I have a hypothesis of major significance:
As the markets have seesawed for the past six weeks one asset has been consistent: the EUR/YEN cross. The SVB fallout coupled with concern about savings fleeing from other regional and community banks has subsided, allowing for the global equity markets to slough off concerns over undue leveraged risks causing further pain for investors. The Credit Suisse writedown on AT1 bonds — contingent convertibles or COCOS — has dissipated sending the EURO and SWISS currencies to recent highs against the DOLLAR, and, more importantly, versus the YEN.
The EUR/YEN cross is significant as it is an important bellwether of what is known as the global currency trade. The Bank of Japan and Ministry of Finance have forced Japanese interest rates to minus 10 basis points for several years under yield curve control in order to keep 10-year Japanese yields within a designated 50 basis points of the overnight bank rate. The central bank’s effort resulted in the Japanese government owning well over 50% of Japanese bonds, but more importantly has “forced” Japanese investors to search the globe for higher yields resulting in a RELATIVELY WEAK YEN as the currency is sold to purchase foreign assets.
When the BOJ actually widened out its YCC target on December 20, global bond markets shook and the YEN strengthened versus a basket of foreign currencies. As the ECB and the FED, along with other central banks, have raised rates to combat inflation the Japanese central bank has held rates steady as it announced the retirement of Governor Kuroda and the appointment of a new BOJ leader, Kazuo Ueda. This week will be the first BOJ meeting chaired by Governor Ueda. The market anticipates NO CHANGE as the official rate will remain at minus 10 basis points but the focus for any change will to the YCC policy at present 50 basis points.
The world’s central banks OUGHT to suggest to Ueda to raise its YCC ceiling BECAUSE THE WEAK YEN FROM THE CARRY TRADE IS CAUSING GRAVE DANGER FOR THE GLOBAL FINANCIAL SYTEM. The ongoing carry trade elevates global assets — stocks and bonds — suggesting that financial conditions are still to loose. In a previous blog post I suggested that the FED and ECB should not use the equity prices as the BAROMETER of financial conditions but look at other metrics like consumer debt and certainly the rollover of commercial real estate loans.
Recently, the Dallas FED reported lending conditions have tightened a great deal. Chris Whalen and others have noted many times that banks were tightening lending as deposits exited, and with many loans coming due for rollover lending rates will move higher than the free cash of three years past. The Japanese are gaining a huge PRICE advantage through a weaker YEN as the BOJ has used its monetary policy to effect its currency in an advantageous outcome. THIS IS FORCING THE FED, ECB and OTHERS TO BE MORE AGGRESSIVE IN THEIR INFLATION TARGETING AS JAPANESE LIQUIDITY ELEVATES MYRIAD ASSET CLASSES AROUND THE GLOBE.
The S&Ps and other other equity markets continue to gain even as real yields on overnight lending approach a real yield of ZERO. In addition, GOLD, SILVER and platinum, the favorites havens for high negative real yields have continued to RALLY EVEN AS CENTRAL BANKS put forward hawkish positions on future interest rates. It has to be BOJ/Japanese liquidity fueling the global levitation. It’s time for the G-7 and Yellen/Lagarde to say enough.
But this is just theory on my part. If you want to discuss, analyze the euro/yen in relation to the various asset classes. Tonight we get the next bout of Japan CPI so let’s see what this brings. As an aside, the TECHNICALS certainly DO NOT FAVOR ANY YEN STRENGTHENING. Just putting some thought into current global financial conditions.