2 Things the European Investment Grade Fixed Income Team Talked About Last Week

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  1. Bank of Japan – Some Further Thoughts

As we have had more time to digest the announcements from the Bank of Japan (BoJ) last Wednesday, there are a number of things that catch our attention. Firstly, my old university economics professor used to teach me that “you can control the price of something, or you can control the quantity of something, but you cannot control both the price and the quantity of something”. Yet that appears to be exactly what the BoJ are trying to do. Announcing a move to Yield Curve Control, the BoJ are targeting a rate of around 0% on the 10-year Japanese Government Bond (JGB), whilst simultaneously maintaining the annual pace of JGB purchases at the current run rate of JY80trn per year. The pledge to keep the 10-year JGB rate around 0% may involve bond purchases being less or more than they have been so far – less if the 10-year JGB continually trades below 0%, more if it continually trades higher than 0%. So there’s an inherent inconsistency in both these targets. Maybe, as ex-U.S. Federal Reserve Chairman Ben Bernanke suggested, the BoJ was concerned that dropping the JY80trn yearly purchase target would lead market participants to think that the BoJ was “tapering” its Quantitative & Qualitative Easing programme.

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Fed Monetary Policy: A Moving Target

United States federal reserveAs expected, the Federal Reserve Board yesterday left interest rates unchanged following the September meeting of the Federal Open Market Committee. In its statement following the meeting, the FOMC said, “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”

The Fed appears to be moving its targets. Chair Janet Yellen cited the need to wait for further improvement in the economy, even though there is evidence that the Fed’s goals have been achieved. She indicated that Committee members will continue to assess economic conditions but made no commitment on the timing of a rate increase. According to Bloomberg, the futures market places a 59% probability on a December hike, but the Fed’s shifting views make that uncertain.

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Key Take Aways from Today’s Bank of Japan Meeting

WFL_0941. Following a comprehensive assessment of monetary policy settings, the Bank of Japan (BoJ) this morning announced “tweaks” to their settings rather than radical changes. Prior to the meeting, press reports had suggested that the BoJ were split in terms of the actions that were deemed necessary. That in turn meant there was a wide spread of expectations in the market as to what would be announced today. The first “tweak” is to shift the focus of monetary stimulus from expanding the money supply to controlling the yield curve. The second “tweak” is to commit to “inflation-overshooting” with the monetary base expanding until inflation stabilises above the 2% target.

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3 Things the European Investment Grade Fixed Income Team Talked About Last Week

Finding the solution1. Japanese Government Bonds – Canaries in the Coalmine?

In late January 2016, the Bank of Japan (BoJ) surprisingly cut their deposit rate to -0.10%, despite BoJ Governor Kuroda denying that he had contemplated such an action only a few days previously. That sparked a strong rally in Japanese Government Bonds (JGB’s) that pulled the yield on the 10-year JGB from +0.20% to a low of -0.29% by end-July. Arguably, this move started the global rally in bond yields that also saw 10-year German Bund yields move into negatively yielding territory. One of the other effects of the BoJ’s action was a massive flattening of the JGB yield curve, with the spread between 2-year JGB’s and 30-year JGB’s compressing from a level of 130bps in mid-February to a low of 36bps by the end of June. As with the fall in yield of 10-year JGB’s, this yield curve flattening was mirrored in other global bond markets, as the similar spread in Germany fell from +180bps at end-2015 to a low of 97bps at end-July. Continue reading

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3 Things the European Investment Grade Fixed Income Team Talked About Last Week

  1. 100044252ECB Meeting – Some Further Thoughts

Having had an extra couple of days to digest the European Central Bank’s (ECB) announcement and subsequent press conference, we think that ECB President Draghi will have enjoyed a glass of Chianti this weekend, quietly happy with the job he did last week. For a start, he avoided committing the ECB to any action, even though most investors are expecting that an extension of QE will eventually be forthcoming. That in itself has introduced a more two-way tone to markets in the past few days. Secondly, he has engineered a steepening of the yield curve, which helps the beleaguered Banking sector and offers them some respite from the effects of negative rates. Thirdly, he has given markets an idea of what life may be like when the ECB finally do stop buying bonds, or when they start their own tapering programme. Fourthly, the market probably now needs to start debating when that tapering may occur, rather than blindly believing that QE will forever be extended and/or increased. Fifthly, Draghi again pointed to the fact that central banks on their own cannot boost world economic growth, and that help is needed on the fiscal side. This argument is increasingly gaining traction and appears to be gaining credence amongst government officials. Lastly, and in quite a clever move, the back up in yields has already eased the fears of investors about bond scarcity. Remember, the ECB currently cannot buy bonds whose yield is lower than the deposit rate of -0.40%. The rise in yields in the last few days has just increased the amount of bonds the ECB can buy. Every cloud has a silver lining. Continue reading

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