Germany, Japan, Italy and Europe

A day after Japanese consumer confidence reflected essentially no improvement since Abenomics took hold 4 years ago, base earnings in October in Japan grew by just .3% y/o/y vs .2% in September and .3% in August. This was almost all offset by a 1.4% drop in overtime and .5% decline in bonus’. This continues to be a big disappointment in that a tight labor market is not resulting in higher pay. It also points to the danger of the BoJ desire for higher inflation because what happens if wages don’t follow. The other thing of note in Japan overnight was the 10 yr JGB yield rising by 1 bp to a whopping 5 bps but that is still the highest since February. Zero, or close to it, is what the BoJ wants the yield to be we know in the ‘yield curve control’ experiment they are managing. What is not part of this ‘control’ is the longer end and the 40 yr yield rose 5 bps overnight to .75%, just a bp off the highest since March. The Nikkei closed up .5% after Monday’s .8% drop and the yen is unch.

German factories were hummin’ in October as orders jumped 4.9% m/o/m, well more than the estimate of up .6% and the y/o/y gain of 6.3% was the most since June 2015. Product wise it was driven by motor vehicles/parts. Car sales are peaking in the US so I hope that ramp up in auto production ends up with inventory outside of the US. Regionally, domestic and non eurozone orders led the way as there was zero growth from within the eurozone.

The sun did shine again in Italy because the political situation is the same mess it’s been in for the past 70 years. The Italian MIB stock index is rallying to a 6 week high and their banks are higher. The recap of their banks will continue and Banca Monte dei Paschi today did pull off a 1b euro debt for equity swap. More though is needed. The Italian 10 yr yield is lower by 5 bps. In terms of valuation, the Italian stock market is trading at a Shiller P/E of 10x. The US is at 26x. There is obviously clear reasons for the gap between the two but that gap is still rather wide. I spoke at a conference last month and asked a few hundred people to raise their hand if the Italian stock market was an interest. Not one person raised their hand. Italy is the definition of a value trap for now but one that can escape it only if real reform takes place from a regulatory and tax perspective. The referendum was the missed opportunity.

Eyes now turn to the ECB on Thursday and because Draghi believes his policy is working we assume he’ll keep on doing more of it past the March expiration. That said, this program is not endless and tapering will most likely begin in 2017. It is then that Mario Draghi will have his ‘oh s**t’ moment on why he got so deep with QE because the reversal will be brutal considering where bond yields are in the region. In the mean time, the banking system continues to get taxed by the negative deposit rate. The euro is down a touch after yesterday’s jump.

Bundesbank President Jens Weidmann said this yesterday: “The idea that central banks can fight the sources of financial and sovereign debt crisis, globalization fears or increasing populism with cheap money is dangerous. If the central bank continuously steps into the breach of politics or even tries to influence democratic processes, that would result in a politicization endangering its independence.”