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.
In the U.S. Treasury market, the curve also flattened from 197bps at end-2015 to a low of 140bps at end-August.
Of course, all of this curve flattening put enormous pressure on banks, insurance companies and pension funds who protested loudly and vociferously. At their upcoming meeting on September 20th/21st, the BoJ had signalled that their policy board would be presented with a “comprehensive assessment” of the effectiveness of its monetary policy settings. The BoJ have also indicated that they have been unhappy about the excessive flattening of the JGB yield curve in recent times and have hinted at actions that might cause a steepening of the yield curve. This could come in the form of further deposit rate cuts or tilting JGB purchases towards shorter-dated maturities and away from longer-dated maturities. This speculation has caused 30-year JGB’s to rise in yield from 0.05% in early July to a current level of 0.55%, and the spread between 2-year JGB’s and 30-year JGB’s to widen from 36bps to 80bps currently. Given the duration effects, that rise of 50bps in the 30-year JGB yield equates to a 12.5% loss in annualised terms over two months. So, whilst global central banks might wish for steeper yield curves, they should be aware of the potential losses that could be caused by their actions in firstly pushing yields to such low levels.
2. ECB Research Suggests Asset Purchase Programme is a Success
Earlier this month the ECB published a discussion paper on its website entitled “The ECB’s asset purchase programme: an early assessment”. Weighing in at 62 pages, it’s a long but necessary read to get a feel for what those in the ECB Tower in Frankfurt think of their unconventional monetary policy actions. Although the footnote on the front of the report says that the paper should not be reported as representing the views of the ECB but rather the authors, the European investment grade fixed income team think its contents may be aligned with what the members of the governing council are thinking.
The authors comments on a number of findings; firstly, that the programme had significant effects when first announced on 22nd January 2015 and secondly, that these effects persisted for several months – about as long as in the case of standard monetary policy announcements. Thirdly, that by reducing private sector holdings of long-dated bonds, central bank purchases should reduce investors’ exposure to duration risk and thus lead to a decline in yields. The authors also note that the asset purchase programme has led to higher prices of sovereign bonds, and thus been akin to a capital injection to many banks via an increased valuation of their bond holdings. Some support for this is evidenced by showing that those banks who hold a larger portfolio share of government bonds saw their share prices do better as they benefitted more from the increase in bond prices. However, Tanguy and the team here might take issue with the authors’ suggestions that the programme helped to increase inflation expectations and guide inflation expectations closer to the ECB’s inflation target. In the opinion of the European investment grade fixed income team, there has been almost no increase in 5-year inflation expectations in 5 years’ time, which is the measure the ECB watches most closely. Finally, in terms of macroeconomic effects, the programme is estimated to be roughly comparable to a decrease in standard policy interest rates by 1 percentage point.
According to the authors, three broad lessons can be learnt from their analysis of the programme so far:
- For any given amount of purchases, the biggest bang for your buck (or macroeconomic benefit) comes from longer-duration assets
- Explicit forward guidance is useful when combined with implementing QE-type programmes
- Clear communication around the programme, potential extensions and the plan for the asset portfolio at the end of the purchasing programme is vital.
Over the course of the next 12 months, the ECB will have plenty of opportunity to take these three considerations on board.
3. Things to Watch for this week :
There are four central bank meetings this week, all happening around the same time, giving us plenty to watch and digest. We expect the Reserve Bank of New Zealand to leave rates unchanged at this meeting, although they do have an easing bias. We like long duration positions in the front end of the Kiwi curve, in anticipation of rate cuts later this year in an attempt to weaken the currency. The Norges Bank in Norway is also expected to leave rates unchanged, but we think the decision could be a close call, and we position for this by expecting a steeper yield curve. The Norwegian curve hasn’t followed the recent global steepening of curves, so there’s room for them to catch up.
In the U.S., markets are only pricing somewhere between a 10%-20% of a rate hike and our U.S. colleagues believe that rates will be left unchanged at this meeting. Either way, at current yield levels, both our U.S. colleagues and we believe U.S. Treasuries offer little value, justifying a short duration stance. Finally, in Japan, as mentioned earlier in this blog, there is a lot of speculation as to what the Bank of Japan might do. We believe they will do very little and ultimately disappoint the market, putting upward pressure on 10-year JGB yields. So again, a short duration stance here is advisable to benefit from any potential fall-out from the BoJ meeting.