Theory Officially Triumphs Over Common Sense As Markets Hit Record On More Helicopter Talk
So there are only three charts you need today.
The first is a two-day chart of the yen:
The second is of course the S&P:
And the third comes courtesy of Google Trend:
We talked at length on Monday about what’s going on in Japan and how it’s driving markets to new highs on the way to making Brexit a distant memory in the minds of an increasingly myopic investor community.
Prime Minister Shinzo Abe’s ruling coalition scored an impressive win in Upper House elections paving the way for the extension of Abenomics. But here’s the thing: there’s not much to extend. The Bank of Japan is monetizing the entirety of gross JGB issuance, owns 55% of the Japanese ETF market, and has of course already cut rates below zero. Here’s some context on just how extreme Haruhiko Kuroda’s brand of accommodation truly is:
(Chart: Credit Suisse)
Spot the odd one out.
And so, with options for further easing limited, it’s time to call in the helicopters in the form of fiscal stimulus. It’s important to understand what this may entail. We’re talking about government spending financed directly by the central bank. Here’s Credit Suisse with a brief description:
“Government spending funded directly by central bank purchases of very long term debt. The central bank then either holds this debt to maturity, or de facto cancels government debt.”
“How feasible? Such a policy would be likely to face significant institutional and political challenges, being the end-game of debt monetisation.”
Yes, the “end-game” for Keynesian meddling run amok. But you can understand why markets love it. After all, this is monetary accommodation on steroids. If we conceptualize rock bottom rates and QE as a punch bowl provided by central banks, think of helicopter money as that same punch bowl, only spiked. Now the real party can get started.
In a break with the counterintuitive moves in yields and gold we’ve seen over the past couple of weeks, today’s rally has all the hallmarks of “risk-on.” Oil is soaring, gold is down…
…and even Treasury yields are acting normally (i.e. moving up as investors abandon safe havens for risk):
That last chart is important. Recall that expectations for Fed dovishness combined with the relatively attractive yield on US paper versus Japanese and German government bonds had kept Treasurys bid even amid the equity market euphoria. The steeper the sell-off in 10s, the more attractive those yields will look, so you can expect a snap back there.
With expectations running high for the arrival of fiscal stimulus not only in Japan, but across markets, let’s look at which countries are most likely to go the helicopter route. Here are some criteria from Credit Suisse:
“Below, we try to quantify both the need and likelihood of fiscal/infrastructure-focused QE being implemented. This is simply judged based on the following factors:
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The need for stimulus: we proxy this by looking at nominal GDP growth over the past 5 years and the unemployment rate versus its 15-year average; weak nominal growth and unemployment above average score well.
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Whether monetary weapons are running out: we judge this by looking at the central bank balance sheet as a proportion of GDP and nominal 10-year government bond yields; a large balance sheet as a proportion of GDP and low nominal bond yields score well.
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Effectiveness of infrastructure QE: very simply, we would judge the efficacy of such a policy on whether or not there is an existing infrastructure shortfall; a low WEF infrastructure quality and global ranking score well.
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The ability to implement fiscal QE: this depends largely on central bank policy flexibility and fiscal constraints imposed on the government, which we score from 1-5, with 5 being the greatest degree of flexibility.
“Treating the euro area as a composite (using data for Germany, France, Spain and Italy) leaves the likelihood ranking with Japan first, followed by the UK second, then the US and finally the euro area.”
Frankly, this is scary. As we’ve noted here before, this is the quintessential example of theory triumphing over common sense. This is governments printing one liability (bonds) and immediately buying them with other liabilities (cash) that they also print, then writing down the purchased liabilities to zero.
Think about that for a second. And then ask yourself what happens to sentiment when central banks need to be recapitalized.
