Japan: Flirting with Helicopter Money

As we already mentioned in a few articles, the Yen strength over the past year was going to be a problem somehow for PM Abe and the BoJ. After reaching a high of 125.86 in the beginning of June last year, USDJPY has entered into a bearish trend since last summer [2015] with the Yen constantly appreciating on the back of disappointments coming from the BoJ (i.e. no more QE expansion). The pair reached a low of 99 post-Brexit, down by 21.3% from peak to trough, sending the equities down below 15,000 (a 30% drawdown from June high of 21,000). The plunge in the stock market was directly reflected in the performance of the Japanese pension and mutual funds; for instance, the USD 1.4 trillion GPIF lost more than USD 50bn for the 12 months through March 2016 (end of the fiscal year). The Fund, as the graph shows below (Source: GPIF) , has been selling its JGBs to the BoJ over the past few years due to Abenomics (the allocation declined from 67.4% in 2011 to 37.8% in 2015) and has mainly been increasing its allocation in domestic and international stocks. With more than USD 13 trillion of sovereign bonds trading at a negative yield – the Japan Yield Curve negative up to 15 years – you clearly understand why we am always saying that Abe and the BoJ cannot lose against the equity market.

A the situation was getting even worse post-Brexit, with the Yen about to retest its key 100-level against the US Dollar, the Yen weakness halted suddenly on rumours of potential ‘Helicopter Money’ on the agenda.

It started when Reuters reported that former Fed chairman Bernanke was going to meet PM Abe and BoJ Kuroda in Tokyo to discuss Brexit and BoJ’s current negative interest rate policy. However, market participants started to price in a new move from the BoJ – i.e. Helicopter Money, a term coined by American economist Milton Friedman in 1969. In his paper ‘The Optimum Quantity of Money’, he wrote:

‘Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.’

In short, Helicopter Money is a way of stimulate the economy and generate some inflation by directly transferring money to the nation’s citizens. This money, as a contrary of refinancing operations or QE, will never be reimbursed.

Buy the rumors, sell the fact?

The effect on the currency was immediate, and USDJPY soared from 100 to [almost] 107 in the past 12 years, levitating equities as you can see it on the chart below (SP500 in yellow line overlaid with USDJPY candlesticks). It was confirmed that on the week ending July 15th, the Yen had his biggest drop in the 21st century. The SP500 index reached its all-time high of 2,175 today and in our opinion, the Yen weakness is the best explanation to equities testing new highs in the US.

(Source: Bloomberg)

Talking with Bernanke: Conversations and Rumors

As the meeting was held in private, we don’t have any detail on the conversation. On common sense, you would first think that the discussion would be on the potential BoJ retreat from the market as its figures are starting to be really concerning (35% of JGBs ownership, 55% of the country’s ETF, 85% total-assets-to-GDP ratio). It is clear that the BoJ cannot continue the 80-trillion-yen program forever, and from what we see in Japan [markets or fundamentals], the effectiveness of monetary policy is gone.

However, it looks to me that market participants are convinced that the BoJ will act further, which is to say adopt a new measure. This was clearly reflected in the currency move we saw, and they [better] come with something in the near future if Japan officials don’t want to see a Yen at 95 against the greenback. The next monetary policy meeting is on July 29th, an event to watch.

Introducing Helicopter Money

We run into a series of really nice and interesting articles over the past couple of weeks, and we will first start by introducing this chart from Jefferies that summarizes the different schemes of Helicopter Money very well.

chopper money schematic

We were only aware of the first scheme, where the central bank directly sends money to the households or directly underwrites JGBs. However, as Goldman noted, the second popular scheme would be to convert all the JGBs purchased by the BoJ on the secondary market into zero-coupon perpetual bonds. When you think that a quarter of Japan revenues from tax (and stamps) are used to service debt with the BoJ running out of inventories (i.e. JGBs) to buy, the second scheme makes a lot of sense in fact.

The other part that Goldman covered was on the legal and historical side. As the picture below (Source: Jefferies) shows you, Article 5 of Japan’s Public Finance Law ‘prohibits the BoJ from underwriting any public bonds’. However, under special circumstances, the BoJ may act so within limits approved by a Diet resolution. In other words, the BoJ can underwrite public bonds. The only problem is once Helicopter Money is adopted, it is difficult to stop it. Japan already ‘experienced helicopter money’ in the 1930s after it abandoned the gold standard on December 13th 1931. It first devalued the Yen by 40% in 1932 and 1933, and then engaged in large government deficit spending to stimulate its economy; it was called the Takahashi fiscal expansion (Japan FinMin, Takahashi Korekiyo, also referred as the Japanese ‘Keynes’). As Mark Metzler described in Lever of Empire: The International Gold Standard and the Crisis of Liberalism in Prewar Japan (2006), ‘increased government spending was funded by direct creation of money by the BoJ’.

helicopter primer 2

It was not until 1935 that inflation start rising, and the expansionary policies of Takahashi’s successor after the FinMin assassination in 1936 led the country to a balance of payments crisis and hyper-inflation.

‘Be careful what you wish for’.

In our opinion, as central banks shouldn’t be too focus on the currency, an interesting way of stimulating an economy would be by transferring money directly to citizens’ account. The BoJ could put a maturity date to the money they transfer (i.e. the citizen has one year maximum to spend the money he received), and ‘obliged’ their citizens to spend it on Japanese goods, therefore stimulating the internal demand and eventually leading to a positive feedback loop.

The announcement of additional measures from Japan in the near future should continue to weigh on the Yen, and USDJPY could easily re-reach 110 quite quickly if rumors become more and more real.

Eyes on Yellen (and global macro)

As we are getting close to the FOMC statement release, we were reading some articles over the past couple of days to understand the recent spike in volatility. Whether it is coming from a ‘Brexit’ fear scenario, widening spreads between core and peripheral countries in the Eurozone (German 10Y Bund now trading negative at -0.5bps), disappointing news coming from US policymakers this evening or more probably from something that we don’t know, we came across some interesting data.

First of all, we would like to introduce an indicator that is getting more and more popular these days: Goldman’s Current Activity Indicator (CAI). This indicator gives a more accurate reflection of the nation’s GDP and can be used in near real-time due to its intra-month updates. It incorporates 56 indicators, and showed a 1-percent drop in May to 1.2% due to poor figures in the labor market and ISM manufacturing data (see chart below).

Chart 1. Goldman CAI (Source: Bloomberg)

The implied probability of a rate hike tonight is less than 2% according to the CME Group FedWatch, and stands only at 22.5% for the July meeting. If we have a look at the Fed Dot Plot’s function in Bloomberg, we can see that the implied FF rates curve has decreased (purple line) compare to where it was after the last FOMC meeting (red line), meaning that the market is very reluctant to a rate hike in the US.

Chart 2. US Feds Dot Plot vs. Implied FF rates (Source: Bloomberg)

June hike, why not?

Many people have tried to convince me of a ‘no June hike’ scenario, however we try to understand why it isn’t a good moment for Yellen to tighten. Oil (WTI CL1) recovered sharply from its mid-February lows ($26/bbl) and now trades slightly below $48 (decreasing the default rate of the US high-yield companies), the US Dollar has been very quiet over the past 18 months (therefore not hurting the US companies’ earnings), the SP500 index is still trading above 2000, the unemployment rate stands at 4.7% (at Full employment) and the Core CPI index came in at 2.1% YoY in April.

However, it seems that US policymakers may have some other issues in mind: is it Eurozone and its collapsing banking sector, Brexit fear (i.e. no action until the referendum is released), CNY series of devaluation or Japanese sluggish market (i.e. JPY strength)?

The negative yield storm

According to a Fitch analysis, the amount of global sovereign debt trading with negative yields surpassed 10tr USD in May, with now the German 10Y Bund trading at -0.5%bps. According to DB research (see chart below), the German 10Y yield is the ‘simple indicator of a broken financial system’ and joins the pessimism in the banks’ strategy department. It seems that there has never been so much pessimism concerning the market’s outlook (12 months) coming from the sell-side research; do the sell-side firms now agree with the smart money managers (Carl Icahn, Stan Druckenmiller, Geroge Soros..)?

Chart 3. German 10Y Bund yield (Source: DB)

10Y bund DB.jpg

ECB Bazooka

In addition, thanks to the ECB’s QE (and CSPP program), there are 16% of Europe’s IG Corporate Bonds’ yield trading in negative territory, which represents roughly 440bn Euros out of the outstanding 2.8tr Euros according to Tradeweb data. If this situation remains, sovereign bonds will trade even more negative in the coming months, bringing more investors in the US where the 10Y stands at 1.61% and the 30Y at 2.40%. If we look at the yield curve, we can see that the curve flattened over the past year can investors could expect potentially LT US rates to decrease to lower levels if the extreme MP divergence continues, which can increase the value of Gold to 1,300 USD per ounce.

Chart 4. US Yield Curve (Flattened over the past year)


(Source: Bloomberg)

Poor European equities (and Banks)

However, it seems that the situation is still very poor for European equities, Eurostoxx 50 is down almost 10% since the beginning of June, led by the big banks trading at record lows (Deutsche Bank at €13.3 a share, Credit Suisse at €11.70 a share). The situation is clearly concerning when it comes to banks in Europe, and until we haven’t restructured and/or deleveraged these banks, systemic risk will endure, leaving equities flat (despite 80bn Euros of money printing each month). Maybe Yellen is concerned about the European banks?


Another issue that could explain a status quo tonight could be the rising fear of a Brexit scenario. According to the Brexit poll tracker, leave has gained ground over the closing stages, (with 47% of polls for ‘Brexit’ vs. 44% for ‘Bremain’). This new development sent back the pound to 1.41 against the US Dollar, and we could potentially see further Cable weakness toward 1.40 in the coming days ahead of the results. Many people see a Brexit scenario very probable, raising the financial and contagions risks and the longer-term impact on global growth. It didn’t stop the 10Y UK Gilt yield to crater (now trading at 1.12%, vs. 1.6% in May), however a Brexit surprise could continue to send the 5Y CDS to new highs (see below).

Figure 1.  FT’s Brexit poll tracker (Source: Financial Times)


Chart 5. UK 5Y CDS (Source: Bloomberg)


CNY devaluation: a problem for US policymakers?

Eventually, another problem is the CNY devaluation we saw since the beginning of April. The Chinese Yuan now stands now at its highest level since February 2011 against the greenback (USDCNY trading at around 6.60). we are sure the Fed won’t mention it in its FOMC statement, but this could also be a reason for not tightening tonight.

Conclusion: a rate hike is still possible tonight

To conclude, we are a bit skeptical why the market is so reluctant for a rate hike this evening, and we still think there is a chance of a 25bps hike based on the current market situation. We don’t believe that a the terrible NFP print (38K in May) could change the US policymakers’ decision. Moreover, even though we saw a bit of volatility in the past week (VIX spiked to 22 yesterday), equities are still trading well above 2,000 (SP500 trading at 2,082 at the moment) and the market may not be in the same situation in July or September.

The Euro Strength and the ECB’s options

The point of today’s article is to debate a little bit about the ECB meeting next week (March 6th) and what are policymakers’ options to counter a strong ‘Euro’ combined with low inflation.

1. The ‘Euro Strength Story’

However, let’s first review the few factors that have contributed, in our opinion, to the Euro strength over the past year. The first indicator we usually watch is the peripheral-core spreads, which determines the Euro zone risk and investors’ sentiment about the global outlook of the Euro area. To give you an idea, the Italian and Spanish 10-year yields are now trading at their multi-year lows (2006 levels) at 3.47% and 3.49%. Since the famous ‘Whatever it takes’ phrase pronounced by Mr. Draghi in July 2012 (27th) followed by the introduction of the OMT program one week later, the single currency has constantly been pushing up against the greenback as policymakers’ support brought back investors’ interests in the Euro zone. Below, there is a popular graph that we like to watch overlaid with EURUSD spot rate, the 3-year Spain-German yield spread. As you can see it, the narrower the spread (white line, inv. scale), the stronger the Euro (purple line)…

(Source: Bloomberg)

The second indicator that played in favour of the Euro strength was the divergence between the ECB and Fed’s Balance Sheet Total Assets. After the Fed announced its QE-4-Ever ($85bn monthly purchases) in the last quarter of the year 2012, the central bank’s balance sheet has constantly been surging since then, increasing the money supply and therefore impacting the value of the US Dollar. As you can see it on the table below, the Fed’s B/S expanded from $2.91tr in December 2012 to $4.15tr reported in mid-February this year, which represents a 42.6% increase. At the same time, the ECB, unlike the other major central banks, has largely refrained from using its money-creation powers and its assets holdings were reduced from €3.02bn to €2.19bn (-27.5%).

Source: Bloomberg; ECB (ECCSTOTA Index) and FED (FARBAST Index)

Therefore, below is another chart that we like to watch overlaid with EURUSD, the Fed-to-ECB Balance sheet ratio. As you can see it, the ratio (yellow line, inversed scale) is up from 0.9000 to 1.3783 over the past year, while EURUSD is up 8 figures down from 1.3000.

(Source: Bloomberg)

The last point that played a role in the ‘Euro strength story’ would be the big quarterly increases in the surplus of the EZ payments current account. Current account, which spots the difference between a nation’s savings and its investments, is an important indicator about an economy’s health. According to Eurostat, Euro Zone current account showed a surplus of 221.3bn Euros over the 12 months to December 2013, compared to a surplus of 128.6bn Euros a year earlier (surplus means basically that the Euro is a net creditor to the rest of the of the World).

After its low of 1.2040 reached on July 27th 2012, EURUSD is now trading around the 1.3800 level, which seems to be ‘uncomfortably too high’ for policymakers. Therefore, Draghi has now two issues, which are a low inflation rate combined with a ‘strong’ Euro. We saw last week that final annual EZ inflation edged up 0.1% to 0.8% in January, but still remains well below the ECB 2-percent target. Private loans have been contracting for twenty consecutive months (-2.2% in annual terms in January) and Money supply growth (M3) in the Euro still sits at low levels compared to the ECB’s 4.5% reference rate (+1.3% YoY in January).

In addition, the decline of the German CPI (Flash Feb eased to its lowest level in 3-1/2 years at 1.0% YoY in February, down from 1.2% YoY the previous month) is adding pressure to other countries of the Euro area, as they need to have a lower inflation than Germany in order to regain competitiveness.

2. The ECB’s options…

The market is talking about further easing, however it seems to me that Mr. Draghi is running out of options. Quantitative easing is out of the question as the Germans won’t approve it for the moment. Then, we believe that another LTRO (3rd one) wouldn’t be successful as banks are still stuck with the LTRO1 and 2 reimbursements. In addition, it may have a negative impact on the single currency in the short term (250 pips ‘correction’ two weeks following the first two announcements, however liquidity will continue to keep sovereign yields at multi-year low levels and therefore support the Euro). Eventually, there are market talks of negative deposit rate, but it seems to me like the ‘tool of the last resort’ and we believe the situation is not that critical yet. When we asked the question to Thomas Stolper (Chief FX Strategist at Goldman Sachs), he added that negative deposit rate is a dangerous tool: ‘there is a risk that banks actually pass negative carry on excess liquidity on to their clients, which is risky in the periphery where this could be counter-productive’.

The only option next Thursday remains a tight cut in the refi rate (probably 10 bps), which we believe is strongly priced in. Therefore, the lack of reaction from ECB policymakers could continue to push EURUSD to higher levels (1.4000 at first, Sep-2011 levels), and will also benefit (as we saw yesterday) from global equity flows (as they continue to favour inflows into Europe).