Recap 3-13-12

Main Items:

  • US headline Retail Sales increased 1.1% in Feb as exp, vs 0.4% prev. The Retail Sales Control increased 0.5% MoM, also inline, vs 0.7% prev. Furthermore, last month’s figures were revised higher.
  • Fed’s CCAR results were reportedly very positive. JPM announced a $15bn share buyback plan, along with a dividend boost. The Financial Sector was the best performer today by a wide margin.
  • US NFIB Small Business Optimism increased to 94.3 vs 94.5 exp and 93.9 prev
  • FOMC statement was broadly inline with expectations, but the larger surprise was the market reaction.
  • The BOJ eased policy marginally, but left the target for the asset purchase program unchanged as expected. However, it expanded the low interest loan scheme by 2trn Yen.
  • The Fed released its “worst-case scenario” criteria for bank stress tests yesterday which include 13% unemployment, 50% drop in stocks, 21% decline in housing prices and a significant contraction of other major global economies. The most recent stress test results will be published on Thursday after the close.
  • Spain’s deficit target was raised to 5.3% of GDP from 4.4%, according to EU president Juncker. This compares to Spain’s target of 5.8% announced a couple weeks ago.
  • Japan will buy 65 billion yuan ($10.3 billion) of Chinese government debt, the country’s finance minister said on Tuesday – Reuters

Overseas:

  • German Zew Survey of Economic Sentiment jumped to 22.3 in March vs 10 exp and 5.4 prev.
  • French CPI decelerated to 2.5% YoY in Feb vs 2.6% exp and prev.
  • UK RICS House Price Balance improved to -13% in Feb vs -14% exp and -16% prev
  • Swiss Producer & Import Priced improved to -1.9% in Feb vs -2.4% exp and prev.
  • AU NAB Business Confidence declined to 1 in Feb from 4 prev

Upcoming Data:

  • Tues: FOMC, BoJ, ZEW Survey, US Retail Sales
  • Wed: UK Unemployment, EU CPI,
  • Thurs: SNB, EU Employment, US PPI, Jobless Claims, Philly Fed
  • Fri: Quadruple Witching, quarterly share rebalance for the S&P indicies

Commentary:

I think the fact that the BoJ expanded its loan program rather the APP suggests that it continues to harbor reservations about the effectiveness of QE at this juncture. I’ve noted in the past that historically, QE has done little to support the Japanese economy or weaken the Yen, except for the first instance of QE which caused JGB term premiums to collapse. Contrary to market perceptions that additional QE will help, I think the BoJ is correct on this. The reason is straight forward – QE is conducted via excess bank reserves, which has to stay within the Japanese banking system. During a liquidity crisis, the excess reserves provide a significant boost to liquidity, which offsets fears of a bank collapse. However, in normal periods, once excess reserves hit a certain level, the additional liquidity available to the banks does very little to spur lending, or growth. After that level is reached, the main mechanism by which QE affects growth is the compression in the term premium on the yield curve. However, once the term premium reaches low levels, as it has now, this channel becomes ineffective as well. Finally, QE usually has an initial deprecating effect on the currency. However, this is usually a result of a decline in the term premium, not because of an expansion in broad money. (Remember that excess reserves are stuck in the banking system, so unless there is new lending & additional leverage, the effect on the currency is limited) The general idea here is that QE only works up to a certain point, just like any other monetary policy measure. Japan, and possibly the rest of the G10, may already there.

Now, one could argue that Japan may decide to intervene in the FX market to weaken the Yen. However, this is the domain of the MoF, rather than the BoJ. On a PPP basis, USDJPY is not that far from ‘fair value,’ which is one reason why MoF interventions in the past few years have been limited. This factor remains in effect today.

I think a number of strategists (equities strategists especially) misunderstand this. Japan remains a country with secularly bad demographics backdrop. I think the Nikkei will eventually trade at single digit PE’s, vs 23.6(!) now. USDJPY is likely to trade lower once fiscal year end is over at the end of the month.

Separately, note that US 10y yields appear to be at a critical technical juncture. On a purely technical basis, risk reward for a short looks very attractive.

Also, JPM notes that foreigner now own a record 76.3% of Australian Central government debt. Remember Greenspan’s bond yield ‘conundrum?’ Looks like we’re getting the Australian redux…

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