The side effects of global QE: Nikkei 225 in free-fall
The trading session on May 23rd in Japan was interesting to say the least. The Nikkei 225 ended the day down 7.32%, the broader Topix index was down 7.2%, and the emerging growth index Mothers was down an eye-watering 9.7%. These are extreme moves by any standard, but probably over-due as we hinted at here: https://nipponmarketblog.wordpress.com/2013/04/22/marginally-risky-bulls-on-the-loose-in-the-tse/
The JGB market fared no better with futures contracts on the 10-year JGB falling 0.73 to 141.17. They earlier slid as much as 1.2, triggering the circuit breaker on the Tokyo Stock Exchange. The 10 year JGB yield ended the day at 0.955%, and the 5 year JGB yield closing at 0.425% after significant intra-day volatility. At one point the BoJ stepped in and injected 2 trillion yen ($19.4 billion) to try to stem volatility after the circuit breaker halted trading in JGB futures. The following charts courtesy of ZeroHedge demonstrate the moves:
Yields are now at the highest level in a year, and up significantly from their lows in April before the BoJ announced it’s QE program.
All this was on the back of testimony from Federal Reserve chairman Bernanke, who first seemed to hint that there was no ‘tapering’ plans in the offing with regards to QE, only to then say that if labour markets improved sustainably over the next few months then some sort of pull-back in QE was likely. In addition, in a press conference yesterday BoJ governor Kuroda did not seem too concerned about rising JGB yields, which the market seemingly took as a signal to sell.
One should obviously be careful not to read too much into one trading session. Afterall the Japanese market is up around 70% since late last year, so some form of correction was inevitable as we hinted at here: https://nipponmarketblog.wordpress.com/2013/04/22/marginally-risky-bulls-on-the-loose-in-the-tse/
As for the size of today’s move, one also has to remember that a very large proportion of trading in Japanese equities is carried out by foreign investors, and most of those are not committed to holding Japan over the long term, but they have been very happy to ride the wave upwards since late last year.
Imagine a large room (Japanese equities) with a single door (the Tokyo Stock Exchange), through which a small number of people (investors) trickles in every day in an orderly fashion. After 8 months all of the investors in the room suddenly and simultaneously perceive a reason to exit the room, and when that happens the single door through which they came in simply is not big enough to accommodate all of them in an orderly fashion. In other words – in terms of market liquidity, the Japanese equity market simply is not deep enough to handle outflows on that scale.
However, a drop of more than 7% in one of the worlds largest stock markets on a day when the only significant news was a few hints from two central bankers (plus perhaps a slightly weaker than expected Chinese PMI), speaks volumes about the amount of liquidity sloshing around in the global financial system, and also about the extent to which ‘fast money’ has entered the Japanese market. Historically, Japan has been perceived as a highly leveraged ‘play’ on global economic activity, and this is still the case. But of course now it also has the added dimension of being the home of the largest monetary experiment in modern history.
Clearly, the Japanese authorities are floundering in terms of expectations management.Today’s intervention in the JGB market has the distinct odour of panic about it, and it is probably fair to say that any intervention at all equates to an admission that things are not going according to plan. In addition, there are already signs of inconsistencies in the signals coming out of the BoJ regarding appropriate levels for interest rates, and as we mentioned in an earlier piece, the elected politicians (i.e. not financial market experts) in the government are becoming increasingly uneasy about the pace with which both the Yen and the equity market has moved over the past 8 months or so. Please see this piece for more on this issue: https://nipponmarketblog.wordpress.com/2013/05/19/too-much-of-a-good-thing/
It seems clear to NipponMarketBlog that the grand monetary experiment looked very attractive on paper to Kuroda et al. when it was first conceived, but now that it is underway it is quite obvious that the BoJ has underestimated market volatility (especially in the JGB market) as well as the deep-seated doubts and cynicism among global financial market participants regarding Japan’s ability to pull itself up by the boot straps from its economic malaise.
After nearly two decades of fiscal, monetary and structural reform policy ineptitude, one could be forgiven for being sceptical about the government’s and the BoJ’s ability to solve Japan’s many problems.
As we have mentioned several times, we do not necessarily believe this is the end of the road for the Japanese bond or equity market. The BoJ still has significant amounts of ammunition left (as demonstrated by today’s intervention in the JGB market), and considering what is at stake in this ‘all-or-nothing’ monetary experiment that it has created, it stands to reason that they will stop at nothing to try to stabilize markets, even if this includes buying large amounts of Nikkei225 futures outright. After all, they are already buying REITs, so conceptually it would be only a small step to decide to also include other types of equities in the buying program.
In this context it is worth keeping in mind that the BoJ can effectively ‘manufacture’ as much liquidity as they need, so at least in the short term the funding of such buying programs will be straightforward. Of course, someone has to pay for that in the end, and most likely it will end up being the average Japanese saver who will be made to pay for it indirectly through much higher inflation rates in the future. But if this is what it takes for the government and the BoJ to attempt to stabilize JGB and equity markets in the short-term, then NipponMarketBlog is certain that this is a cost they are willing to accept.
Stabilizing financial markets is clearly something the BoJ can do in the short term, but in the long term the real issues are growth, deflation, an inefficient and inflexible coporate sector, government deficits and debt. Ultimately most of these issues are driven directly or indirectly by significant changes to Japan’s demographics, and this is not an issues that can be solved with monetary policy or even fiscal policy.
NipponMarketBlog has the distinct feeling that Japan’s monetary policy is akin to a car speeding along on the road, and from the outside everything looks normal. However, but if you look inside the car you’ll find that it has no steering wheel but only an accelerator and a slightly dubious looking brake. We hope for Japan’s sake that there are no bends in the road coming up.
Please see this piece for our thoughts on what one might call the End Game in Japan: https://nipponmarketblog.wordpress.com/2013/04/25/japan-is-insolvent-but-please-dont-worry/