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The Beatings Will Continue Until Morale Improves


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The global push for negative monetary policy rates has taken a turn to the bizarre and frightening. In an attempt to combat deflation with a combination of weapons, Quantitative Easing (QE) and Negative Interest Rate Policy (NIRP), the Bank of Japan (BOJ), and the European Central Bank (ECB) are actually enhancing the likelihood of a deflationary spiral by hobbling their respective banking systems.

When BOJ Governor, Haruhiko Kuroda, was asked by parliament this Thursday whether or not there was a problem with Japanese banks, who are participating in the BOJ’s QE program, selling the BOJ Japanese Government Bonds (JGBs), he replied, “There has been no trouble with the BOJ’s bond purchases and even if financial institutions are hesitant to sell bonds, interest rates may decline, enhancing the effects of monetary easing.” In my mind, what Governor Kuroda said there was, “If you (banks) don’t part ways with your JGBs and sell them to us, we are going to move the rate we charge you (remember, negative rates, so think backward!) on excess reserves even higher, and punish you until you cough up the bonds.”

It’s hard not to think that global central banks like the BOJ and the ECB have embraced policies that are putting the global economy in further jeopardy. Japanese banks do not want to sell their government bonds to the BOJ because they have little else to do with the proceeds other than to keep them at the BOJ, who will charge them to hold the proceeds. With increased nominal and risk-based capital requirements, the banks can’t afford to get fast and loose with their lending standards. Even if they did loosen up, the loan demand is not there. What we are seeing in Japan and Europe is a deflationary spiral. Body-checking the banking system by engaging in a policy that wipes out net interest margins by flattening yield curves, thus denying the banks the ability to earn, carry, and strengthen their capital positions—seems an awful lot like the last thing the respective central banks should be doing.

It was interesting that on the same day that Governor Kuroda rattled his saber at Japanese banks, the ECB’s Jens Weidmann said this regarding NIRP, “If through the effect on, for instance, the stability of banks our measures produce the opposite of what we want, then it wouldn’t be smart to embrace them in the first place.” It seems that we are meeting Herr Weidmann’s condition, “what wouldn’t be smart.”

The dual central bank policies of QE and NIRP are not only the wrong policies to keep economies from deflationary spirals, but are actually increasing the likelihood of them by harming the banking sector. As Chris Ahrens said in his latest piece, “Negative Rates-A Vicious Circle:”

“Central bank policy of taking QE to the point at which a problematic excess of excess reserves have been created implies that a limit has been breached. It is an absurdity that a charge now has to be assessed to drive this money back into the market, the consequence thereof has been to diminish the banks’ ability to generate income by fostering a lower absolute rate of interest and a flatter yield curve. At current extremes, QE can be thought of as the carrot (lowering market rates and creating reserves) while the negative administered rates are the stick (penalizing banks for not lending), leading the financial system down the pathway to perdition (making loans it otherwise wouldn’t choose to make).”

The BOJ and ECB are committed to going down the QE and NIRP path. I believe that the gravitational pull of negative yields, created by this path (the German five-year is currently negative 37 basis points and the Japanese 10-year is negative eight basis points) will continue to keep our risk-free rates low. It’s tough to say “buy the dips” when the five-year Treasury yields 1.25% and the 10-year Treasury yields 1.77% but, buy the dips! Additionally, as we saw two weeks ago, earnings problems for large European Banks create systemic risk worries in the financial markets and subsequently, severe risk aversion. Therefore, I would stick to high-quality assets, and I include municipals to that high-quality list. A repeat of the disruptions we saw two weeks ago can produce “cross over buying” into municipals.

Member SIPC & FINRA. Advisory services offered throughSWBC Investment Company, a Registered Investment Advisor.

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