A Big Central Banking Inflection Point RIGHT NOW

Central banks are going to be useless in their attempts to turn around each bank’s respective economy. I In terms of time and level, I think we are really close to an inflection point, RIGHT NOW.


* The BOJ yesterday chose to expand on their near ZIRP (zero interest rate policy) yesterday. The BOJ is fighting twin demons: a very weak economy, and a currency which has been consistently the strongest major currency over the course of the last few years, which in turn they blame for their economies woes. Here is the FINE print from yesterday morning’s press release:


     ”Yesterday, the Bank of Japan cut its overnight call rate target to a range of zero to 0.1 percent from 0.1 percent and established a 5-trillion-yen ($60 billion) fund to buy government bonds  and other assets. It acted after the yen’s surge to a 15-year high last month hurt exports.


    The bank said it will use the new fund to buy about 3.5 trillion yen in government debt and the remainder to purchase assets such as commercial paper, exchange-traded funds and real- estate investment trusts.”


Yes sports fans, the BOJ will be buying ETFs and REITs;  in other words, the stock market! No wonder why the markets did well yesterday. Central Banks are the buyers of last resort, and have the ability to print as much money as they want, be it dollars, yen, euro’s or the yuan. While one should not underestimate how much further central banks can propel markets, it is important to realize that central banks are the buyer of last resort, and after they are done, or think they are done, private investors will be dumping the same assets the Fed pushes higher. 


There are three basic reasons why central banks purchase assets:


1> The original reason was to put additional money in the banking system, so the banks can turn around and lend that money. In the post WW2 era, the fractional reserve system meant that $1 additional dollar of bank reserves could spawn an additional $8 to $15 of lending. In the post 2007 bubble environment, the Fed is pushing on a string, as banks are sitting on over a half trillion of excess reserves which they have no interest in lending out. Scratch this reason off the current list of being relevant;


2> Traditionally, when the central banks lower interest rates, (which can happen by setting the short term rate low, or purchasing long dated securities to affect that part of the yield curve), the lower rates are supposed to spur additional economic growth as businesses and consumers will be encouraged to borrow more at the lower rates, which in turn will help spur economic activity. But with short term rates at zero, and long term interest rates at generational lows, pushing interest rates lower is symbolic at best, but will have little impact on economic activity.


3> This leads us to the wealth effect, which lower rates are supposed to engender: A rising stock market which comprises a decent percentage of US household’s wealth should encourage businesses and consumers to spend more, which in turn should help the economy. Despite the stock markets dramatic rally over the last 18 months, stock prices are lower today, than they were in 4 of the last 6 years. In other words, most people in the US are still losers in this game. Aside from stocks, housing comprises a large portion of household wealth, and affects more people than the stock market; and housing is off 27% over the last few years. So any attempt to inflate assets markets to engender a return of the positive attributes of rising wealth effect are going to fail, since so many in the US are watching their homes remain depressed from the peak levels of 2006.


This brings me to a technical term, known as “we are screwed”. Central banks around the world are now grasping at straws, or REITs and ETF’s in an attempt to create economic growth. Yet the basic premise behind what they will actually accomplish is flawed. The central banks are basically irrelevant, except for one point. The creation of money will eventually result in inflation, and asset bubbles, as investors around the world realize that the more money the central banks print, the less value that currency will retain. The US’s Fed has been undertaking a very public discussion on the merits of printing more money, under the guise that this will engender additional economic growth, with such acronyms as QE light, QE 1.5 or QE 2 being used to discuss the permutations of current and anticipated money printing policies.


The Japanese recently tried intervening in the currency markets to push down the value of the Yen, however, after purchasing approximately $25 billion of Yen (and selling of US dollars), the Yen quickly rose from 83 yen per dollar to 86. Subsequently, the Yen has returned back to 83 Y/$, effectively rendering the BOJ’s intervention strategy useless. In short, the BOJ would likely need to buy yen, at a pace of $25 billion a week, and do so for many weeks, in effect, they would likely need to accumulate a half trillion dollars of Yen to make a difference. And even after all that, it is hard to say the Yen would not resume its rally. While yesterday’s moves by the BOJ was not expected, the BOJ is under intense pressure to do something to save their economy, so taking interest rates from 0.10% to 0.0%, in addition to a wild asset purchase program, is their last ditch attempt to save the day. The Japanese government has been fighting deflation for the last 20 years, and they have failed. Deflation has a mind of its own, and will cut a destructive swath through the US economy as it continues to plague Japan.


And this morning, the head of the IMF, Dominique Strauss Kahn issued a warning, via the front page of the FT, that central banks should not engage in currency wars to help their domestic economy. In an interview with the FT yesterday Kahn said:


“There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery… Any such approach would have a negative and very damaging longer-run impact.” 


* Since my comments last week about a potential turn in many markets, which I thought would occur on or around the October 8th unemployment data release, various markets have moved closer to my targets:


1.   I have 1.388 as my target for the Euro currency, and it is currently at 1.394;


2.   Gold is nearing the 1360 to 1370 target identified by the folks at Elliott Wave International. Gold, in terms of Swiss Francs or Euros, is well off its high, and seems to be well in need of a correction;


3.   Stocks are within the 1150 to 1174 target range, at 1160 currently, a place where they should correct lower from;


4.   While I think that a down turn in the risk assets described above should accompany a rally in bonds and a drop in interest rates, bonds seem as if they are equally over extended. If there is a down turn in risk assets, then it is very possible that investors will take profits on bonds to help cover losses in risk assets. With yields so low on all maturities inside of 5 years, the only game in town (with some yield) is the 10 year or 30 year bond. Clearly bonds have a mind all their own, and could well be on their way to new high prices, or lows in yield.


Lastly, Chris Carolan, (see carolan.org), who does some amazing work via his “spiral calendar” method of forecasting markets, has pinpointed this week +/- 1 week, as a time when many markets are likely to turn. Given how all the markets are behaving, his timing seems to have an intuitive correctness to it as well.


In short, I expect a turn in stocks, precious metals, and the dollar, and I expect this to happen from current prices, or from levels near current prices, and I expect this to occur this week. The only market which I am not sure about starting a correction, is the US bond market.