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The Bond Column

BoJ Takes Another Step Down the Rabbit Hole as ECB Pauses
Updated: 2016-09-26, 08:55:49 ET
Analyst: David Kelland

This week, the Bank of Japan took the next logical step inthe erosion of monetary policy norms and announced a target for the 10-yearJapanese government bond (JGB) yield of ~0.00%. Japanese bank stocks were themain beneficiaries of the announcement because it showed that the BoJ issensitive to banks' shrinking net interest margins, but the yen did not sell off.Investors had been hoping for a cut to the current overnight call rate targetof -0.10%.

Former Fed Chair Ben Bernanke noted that if the target isperceived as credible, the BoJ should not have to actually buy very many bondsto keep the 10-year yield at its target. Who would speculate against the Bank of Japan unless the economic imbalances were unsustainable? This is also another step on the roadto monetary financing of government deficits because the central bank isessentially writing blank checks (in the form of 10-year JGBs).

In the eurozone, the 'flash' reading for the September MarkitComposite PMI fell to a 20-month low. After the dismal showing for the U.S. ISMsurveys in August, this is worrisome. Surveys do not have the credibility ofofficial data like retail sales, but they do tend to be useful. The EuropeanCentral Bank would have little monetary policy firepower to fight a downturn,especially with its banks burdened by non-performing loans and suffering fromlow profitability in the negative interest rate environment. Nevertheless, theEuro Stoxx 50 is within one big daily gain of a 10-month high. Stock tradersprobably know more than I do about the fundamental nature of the eurozonerecovery. ECB officials have noted that share price declines for eurozonelenders have hampered lending activity. Perhaps the sword cuts both ways andlending will increase as bank stocks rally.

Reuters reported on Friday that six members of the ECB'sGoverning Council said that appetite is low at the ECB for big changes to theasset purchase program. After ECB President Draghi's statement at his lastpress conference that an extension to the EUR80 bln/month asset purchase programhad not been discussed, investors should begin to think about a world withoutasset purchases. For the real economy, that may mean nothing - unconventional monetarypolicy appears to have helped very little. For asset markets, withdrawal ofquantitative easing could be a much bigger deal. If fiscal policy begins totake over the responsibility for growth, interest rates should start to riserather than fall. Fiscal policy has no transmission mechanism. Government moneyfor concrete goes directly to concrete sellers with no possibility of the fundsgetting stuck in the banking system on the way. Reports out this week showedthat German consumers are starting to loosen their purse strings, so that isgood news too.

In the U.S., a steady drip of weaker-than-expected economicdata for August has pushed the New York Fed's Nowcast for Q3 GDP growth down to2.3% from 2.8%. If the U.S. economy canjust limp through the end of the year, maybe it will get a fiscal shot in thearm in 2017. Both presidential candidates have significant infrastructure proposalsand maybe some Republican members of Congress can be browbeaten into supportingthe measures.