(USTs modest belly led steepening on LIGHT volumes) while WE slept; 'Santa is on his back foot', more on BoJ
Good morning … Not sure we’re quite done with BoJ commentary and review.
I’m thinking about the situation and liken it to when Bernanke got the ball rolling, plan in place and then handed the keys TO Yellen … Perhaps this was some of Kuroda’s intention?
I’m going to continue to watch 10yy vs this recently updated TLINE …
3.75% TLINE and 50dMA a touch above 3.80 … All important considerations as THE carry trade may just be changing forever … AND as goal posts continue to be moved and situation evolves, Reuters this morning offers,
… U.S. Treasury yields slipped back from Japan-inspired three-week highs as a result, although recession warnings contained in the 2-to-10 year yield curve inversion did ease to their least negative in more than a month…
… here is a snapshot OF USTs as of 705a:
… HERE is what another shop says be behind the price action overnight…
… WHILE YOU SLEPT
Treasuries are modestly higher with the belly of the curve leading curves a bit steeper this morning. DXY has rebounded modestly (+0.13%) while front WTI futures are higher (+1.4%). Asian stocks were mixed, EU and UK share markets are all higher (SX5E +0.85%) while ES futures are showing +0.5% here at 6:30am. Our overnight US rates flows were unavailable (we were early) while overnight Treasury volume was ~70% of average overall with only 10's (100%) seeing average turnover among benchmarks this morning.… Fed experts have opined that the Treasury 5s10s curve may be the curve segment most impacted by changes in term premia, as here NYFed. So the Tsy 5s10s curve will once again be the focus of our chart treatment this morning-- to illustrate the trend vibes we're broadly witnessing in curves today. The daily chart of 5s10s shows this curve pressing into a topside resistance band this morning: between -9.5bp and -8bp (September's twin intraday peaks). A daily close in 5s10s above -8bp would put this curve into pretty clear air
… Earlier this morning, and in the wake of the BOJ's 'holiday surprise' yesterday, JGB 2yr yields went positive and touched the highest yield seen since early 2016. In turn, the global stock of neg-yielding debt outstanding may have just begun its last leg to extinction as you can see in our last attachment. Are we witnessing the end of an era (neg-yielding debt) and the dawn of a new one (steeper curves and higher term primes)? Things definitely lining up that way based on the view from our perch...
… and for some MORE of the news you can use » IGMs Press Picks for today (21 DEC) to help weed thru the noise (some of which can be found over here at Finviz).
And now for a few words from Global Wall Street’s sponsors … the sellside SAYS …
DB update on, The Bullwhip Effect
A cheerful note for Christmas: In last month’s Bullwhip Effect we highlighted that fewer supply chain issues, better supply of goods and a weakening demand could bring down goods inflation quicker than many may expect. Yesterday, the German Producer Price Index fell by 3.9% (MoM), the second consecutive month, confirming the turn into negative territory the month before. The German PPI is one of the first European inflation numbers to be published and oftentimes a good leading indicator for broader EU inflation data. I am not an economist, so why do I find this interesting? It is bad news for earnings but good news for valuations.
Earnings: In 2022, a shortage of goods allowed companies to raise prices and achieve record profit margins. Q3 earnings for the STOXX Europe 600 were a staggering 32% higher than a year earlier. With better supply and high inventories this trend is likely to come to an end. We expect earnings to fall by 10% next year. However, this applies more to manufacturing and consumer goods companies than to service companies. Labor in the service sector is still in short supply and demand for services still high, allowing service companies to pass on higher costs.
Valuations: As we pointed out in our Q4 outlook, we believe that valuations have troughed. Lower inflation data spark hope for less restrictive central bank policies and a recovery of the still very depressed P/E levels in Europe. Unfortunately, it is still a long way to go and the recent central bank statements have struck a more hawkish tone than we had wished for.
While consensus expects a negative year for equities in 2023, there is a chance that we reach lower inflation data without hitting a severe recession. Historically, inflation around 4-6% has been the sweet spot for equity market returns. On this happy note, merry Christmas, and a happy new year…
Yardeni: Fireworks Before Christmas?
Santa is on his back foot. Fed Chair Powell's presser was hawkish last Wednesday. Thursday's batch of economic indicators seemed to support the hard-landing scenario. Could the Santa Claus rally make a comeback before Christmas despite the Grinch at the Fed? It could, depending on November's personal income report to be released on Friday.
We think that it will confirm that inflation is moderating as measured by the PCED measure of consumer prices. It should also confirm that consumers are still spending, though more on services than goods. It should show that in addition to excess saving, wages are rising faster than prices, boosting consumers' purchasing power. That would all be consistent with a soft landing…
… By the way, the stock market held up relatively well today despite the backup in global bond yields caused by the BOJ's surprise announcement that it would allow Japan's 10-year government bond yield to rise as high as 0.5%. The Era of Free Money is over. So far, the transition back to the Old Normal hasn't been as terrible as touted by the permabears.
AND for some more from Global Wall Street on Japan,
1stBOS: BoJ decided to expand the range of 10-year JGB yield fluctuations
… We continue to think that, starting under the new governorship in April 2023, the BoJ will conduct (1) a historical review of its monetary easing policy over recent decades. In addition, (2) the policy accord between the government and the BoJ will likely be amended to add flexibility to the 2% inflation goal, with the Kishida administration expected to be in favor of the amendment.
Monetary policy changes after (1) and (2) could be more substantial, as the Bank may alter the inflation target and, in relation to that, scrap the socalled “overshoot commitment” on the monetary base, and revise the conditions for scrapping the YCC and the negative interest rate.
Simply, the Bank may try to pave way to regain the flexibility of its monetary policy in a direction that would allow it to end the current YCC policy even if 2% inflation is not achievable. However, the actual conduct of monetary policy will still likely depend on the growth and inflation dynamics into 2024.
DB: Japan's Yield Curve Control 101
The Bank of Japan delivered an early Christmas surprise on Dec 20, unexpectedly chipping away at the ultra-dovish Yield Curve Control (YCC) policy that has anchored global bond markets in recent years.
This sent shockwaves beyond the shores of Japan, where the yen spiked and government bonds slumped. Global bonds and stocks fell. The move was seen as a potential first step away from the ultra-loose monetary policy that has set Japan apart from other markets where inflation and interest rates have surged in recent months.
The BoJ framed the decision to widen the range for 10yr bond yields from +/-0.25% to +0.5% around market functioning. Governor Kuroda said it was not a rate hike (the official rate was unchanged at -0.1%), and announced a quid pro quo with an increase in bond purchases to 9trn yen a month, up from 7.3trn.
This latest edition in our 101 series for generalists takes a step back to analyse how YCC came about, what the impact of it has been and what might happen next.
DB (Saravelos) Here is the Japanese wall of money
Where will the biggest and more sustained market impact be following the BoJ policy surprise this week? In our view it's simple: JPY strength. Japanese investors have already been preemptive sellers of their global asset holdings, especially fixed income. Japanese portfolio flow data show a record amount of foreign bond liquidation over the last twelve months (chart 1). Historically, this would have led to repatriation flows and material JPY strength. But this did not happen as the Japanese hoarded their cash offshore. In USD alone we estimate they cumulated nearly $100bn of balances over the last twelve months (chart 2). This then explains why the yen weakened so dramatically in 2022 despite one of the biggest global asset sell-offs in history: BoJ easing and artificially low JGB yields prevented Japanese repatriation.
A BoJ policy shift then naturally leads to the following flow of funds: Japanese buyers are already overweight USD cash (and other FX). They will use it to buy JPY and JGBs as domestic yields rise. By extension the domestic (and foreign) bond market adjustment is likely to be fairly orderly. By further extension the biggest market impact is likely on FX. We have long been pointing to BoJ policy as a driver of yen weakness and Tim Baker last week outlined seven drivers supporting our bullish JPY forecasts next year. The BoJ policy shift (despite Governor Kuroda's claims to the contrary) should start to put the Japanese "wall of money" to work. There is a lot to move.
Goldilocks BoJ's YCC surprise has limited spillovers (for now)
… We do not expect increased foreign bond liquidation by Japanese investors as a result of the YCC change. A more powerful driver of the changing economics of owning external debt has been sustained policy tightening by other G10 central banks. Even without an acceleration however, ongoing sales could have material implications for some markets (e.g., OATs), where we expect a significant increase in supply….
… Rather than YCC, we think the bigger factor here has been the aggressive increases in the policy rates pursued by other G10 central banks, which have flattened those yield curves relative to the JPY yield curve. This change was most significant this year in the US; since late last year, Japanese investors have already reduced their UST holdings substantially (by roughly ¥20tn; Exhibit 4). These numbers suggest there were private sector liquidations as well, i.e., this was not simply a drain of official sector reserves to defend the currency.
Goldilocks Japan Views: BOJ Widens the 10-Year Band: Why Now?
Goldilocks: FX in Focus: BoJ Widens the Band, and the Possibilities
MS: BoJ Reaction: Surprise YCC Adjustment
The timing was the worst for YCC tweaking this time, given that global central banks are showing ongoing rate hikes, Japan headline inflation is accelerating towards 4.0% y/y, and media news suggested possible reassessment of the policy framework under a new BoJ governor. Accordingly, the market priced in a future BoJ rate hiking cycle as it interpreted this tweaking as a first step of future policy tightening rather than a move for improving market functioning.
We expect the belly of the curve to remain volatile in the near term, while long-end JGBs would be supported by non-negligible increase in the BoJ's JGB purchases going forward. We close JGB 7s20s steepener, but maintain JGB 20s40s flattener.
Wells: Bank of Japan Tweaks, But Will They Tighten?
… While our base case is for no further moves from the BoJ, the risk of another policy change has clearly increased. Should Japanese inflation remain elevated or global central banks maintain a hawkish stance for longer than we expect, we believe modest BoJ monetary policy normalization could take place by around mid-2023.
We view the Bank of Japan's policy tweak as clearly consistent with and supportive of yen outperformance over the medium-to-long term. We have previously noted the yen as a likely outperformer in 2023, with risks now tilted toward even stronger yen gains than our current medium-term USD/JPY exchange rate target of JPY130.
Finally on the Yen, from Bloomberg
…Dollar-yen’s spectacular descent this week has traders looking for downside levels where the cross may land, with the 120’s a possible target zone according to some analysts. In case there was any doubt the BOJ tweak to yield curve control was a major event for currency markets, it is evident in the options complex. USD/JPY option volumes were more than three times as much as the second-most active pair EUR/USD. The $24 billion worth of yen options made up a staggering 43% of all transactions on Tuesday. Some forex traders, however, seem to have been prepared for a BOJ surprise as option volatility had soared going into the policy meeting, with one-day pricing around 23%. Amid the wide range for dollar-yen over the years since JGB 10-year yields were last at 0.5%, a midpoint around the 125 line could be a resting place in the weeks ahead.
… THAT is all for now. Off to the day job…