Morning Commentary: Japanification of the World

Foreign Exchange - Morning Commentary
Japanification of the World
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Even before the COVID-19 crisis, developed economies around the world were already faced with limited monetary policy ammunition while sitting well short of their investment goals.  Due to the unprecedented economic hit delivered by the COVID-19 outbreak, central banks around the world have responded with an impressive array of stimulus measures. 

While there is a growing narrative, at least in the markets, that the end of the crisis is near, central bankers will likely have to do more.  It is important to remember that while recessions can be caused by shocks, the recession continues after the shock has dissipated.  This is due to the negative feedback loop triggered by the shock which overwhelms policy support.  It is reasonable to expect economies to reopen with diminished demand and low discretionary spending.     

As a result, inflation should also continue to be an issue due to the resulting output gap.  Flooding the banking system with liquidity doesn’t create inflation without bank lending.  New credit facilities designed to prevent bankruptcies do not create inflation, and fiscal stimulus to offset lost income due to the virus-driven collapse of the economy does not create inflation.  If anything, the risk for inflation comes from shutdowns as constrained supplies could drive up prices. 

Then what are the additional steps that central bankers can take?  Negative rates are not attractive as it is unclear whether the positives outweigh the negatives.  This leaves the strong possibility that other banks follow the BoJ’s lead and implement yield curve control (YCC).  YCC will allow for better control of the long end of the curve.  It should also enhance fiscal policy by preventing “crowding out” of private investments, due to the normal rise of interest rates due to large government borrowing, and rising yields during a recovery to slow the rebound. 

Granted Japan YCC hasn’t been successful in getting Japan out of its low rates-low inflation trap but this isn’t necessarily the policy’s fault.  Japan initiated YCC after deflationary psychology was deeply embedded in the economy.  Additionally, the government has repeatedly shocked the economy with tax hikes.  On balance, the pros and cons of YCC control make it the next move of choice over negative rates.           
  • US retail sales were down more than expected at -8.7% versus expectations for a -8.0% decline.  Core retail sales were also down  -3.1% but was not as bad as expected.  The US Empire manufacturing series also came in weaker than expected at -78.2 versus expectations for a -35.0 print.
  • The US has followed up on its threat to suspend WHO funding due to claims the WHO failed to share information on the COVID-19 outbreak and taking China’s claims at “face value.” 
  • Several European countries have extended their lockdown periods.  Germany, Italy, France and Spain are expected to extend their lockdowns to May 3, May 3, May 11 and April 26, respectively.  However, these extensions should also come with some relaxation of separation measures.  The UK is also expected to extend its lockdown by 3 weeks.
  • G7 Finance Ministers will meet today, via a conference call, to discuss the possibility of suspending bilateral loan payments for low income countries.  While this is a positive development, the “middle income” countries are still left in a bind as they are not wealthy enough for a strong fiscal response but not poor enough to qualify for relief.  However, it has been reported that the IMF is looking at providing aid to these middle countries.  
  • Australian consumer confidence took a sharp decline, falling 17.7% from last month’s print of -3.8%.  Australia’s labor report will be released tonight and is expected to show a sharp decline in employment despite covering a period that includes the timeframe before the step up in social distancing measures.   
  • Oil prices continue to fall and currently sit below $20/barrel.  The International Energy Agency reported that global demand for oil could fall by 9% this year and that storage tanks would likely be full by the middle of 2020.
  • China continues to provide support to the markets with the PBoC cutting its 1 year Medium Term Lending Facility rate by 20 bps to a record low of 2.95%.  This is also the largest single cut for this facility with prior cuts being either 5 or 10 bps. 
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