With the continued belief that the tone of the global sovereign bond market changed over the past few months when Japan implicitly (and now explicitly) acknowledged that destroying the profitability of one’s banking system in an attempt to achieve 2% inflation is a bad trade off, I want to add a few more thoughts to what the BOJ announced yesterday. By pegging the 10yr JGB yield at zero (or will do their best to do so), they are turning that instrument essentially into a cash equivalent. It then makes more sense to own this paper rather than a short term JGB that is still yielding less than zero (the one yr is at -.25%). If an arb so to speak then follows, we could see a completely flat JGB curve from the short end out to 10 years (yes, 25 bps is still pretty flat). What then happens to the desired steepening of the yield curve the BOJ wants? It then is most likely going to occur in maturities past 10 years where the desire for “yield curve control” will be tested. How much of a rise in long term yields will the BOJ tolerate? Will we see a pegging of the entire curve at some point? Will we maybe see the opposite where buyers of JGBs seeking yield have no choice but to reach into 20, 30 and 40 yr bonds and thus the BOJ never gets the steepening they desire and that their financial system is begging for.
Bottom line, the only call I’m confident in making is that the mid July lows in global interest rates may never be seen again because of the wake up call that central bankers have received from their banking systems. I bring up the thoughts and questions above on what to look for as time moves forward as the QE experiment in Japan is unprecedented in size relative to their economy with a little added bit of NIRP to go along. What happens in Japan thus will have global ripple effects.
As for the Fed, with the economic data over the past month weak (ISM manufacturing, ISM services, payrolls, wages, auto sales, retail sales, and capital spending to name a few), it’s obvious that they have shifted from being data dependent to reaching an “oh s**t” moment. They seem to have woken up and realized that only one hike over an 8 yr recovery with now possibly full employment and inflation near their target (core CPI has been above for 10 straight months) statistically speaking was maybe a mistake and are trying to make amends. If they are intent on raising notwithstanding the data (they seem to have forgotten that labor market data is very lagging) and claim they are not politically motivated and really believe that the case for a hike has truly “strengthened” then I dare them to hike in November as why wait until December, 4 months after Janet Yellen made the case for the next hike? Either way, there will be no way to normalize policy without having a recession and a bear market. This monetary lunch is extraordinarily expensive and is far from free. They have to pick their poison. I say drink it now rather than have to ingest even more later.
Existing home sales in August totaled 5.33mm, 120k less than expected and down from 5.38mm in July. This is the slowest pace of closings since February. As the number of homes for sale fell m/o/m to a five month low, months’ supply fell to 4.6 from 4.7. After rising to 33% in June, the level of 1st time households fell to 31% in August. Again, this is the missing piece to a more robust housing market. Investors bought 13% of the homes sold vs 11% in July.
Bottom line, the NAR again is blaming the dearth of supply and “affordability restrictions” that “continue to keep too many would be buyers on the sidelines.” The fix to this is of course more new homes, especially those priced below $200k. Builders were optimistic in Monday’s NAHB survey that their business will improve but Tuesday’s Starts number is evidence that it hasn’t happened just yet. The housing recovery still remains uneven.