The Bank of Japan’s desperate head fake.
The US stock market was a coiled spring. Stocks had been pushed down relentlessly. Short interest was huge. We’d been expecting a big rally. It just didn’t materialize for longer than a day or two. But on Friday, that coiled spring was released, and stocks bounced nearly 2.5%, to produce the worst January since 2009.
The market had received a couple of central-bank signals that it interpreted as “more free money.” That’s the only thing markets care about anymore.
One of those signals came from the Bank of Japan. As the economy has deteriorated recently, despite years of QE and a near-eternal zero-interest-rate policy, the BoJ decided to cut one of its deposit rates from +0.1% to -0.1%. Headlines screamed Japan had gone “negative,” that it had joined the NIRPs of Europe.
It was a head fake.
It revealed a desperate out-of-options central bank whose scorched-earth monetary policies have led nowhere. And it was a surprise. This is how Daiwa Capital Markets Europe, a subsidiary of Daiwa Securities Group in Japan, explained the phenomenon:
Every time we’ve heard from BoJ officials over the past couple of years there has been one consistent message – imposing a negative interest rate on excess reserves was not on the agenda, not least since it could work against its asset purchase program. And as recently as last week, Kuroda was brazenly asserting that the BoJ was not seriously considering a cut in the interest rate paid on excess reserves.
A year ago, it was the Swiss National Bank that roiled markets when it did what it had vowed it wouldn’t do: abandon the cap on the franc. The franc soared, stocks plunged, currency traders went over the cliff, and everyone learned that central banks, despite their promises, might ruin you.
On Friday, it was the BoJ that pulled that trick. For heightened impact, it rebranded its new promise of wealth creation or whatever as “QQE with a Negative Interest Rate.”
But the head fake goes deeper.
Turns out, the announcement of the negative deposit rate won’t trigger actual negative deposit rates on excess reserves that banks keep at the BoJ because of its tiered system that applies three different interest rates to excess reserves:
- + 0.1% on average outstanding current account balance held throughout 2015.
- 0.0% on current account balances related to banks’ required reserves and the BoJ’s provision of credit through its loan support programs.
- – 0.1% on additional current account balances going forward.
The third category, the only one with a negative deposit rate, doesn’t even have any balances yet. So the impact for now is nil. It only applies to “additional current account balances going forward,” if any. Daiwa:
That means that, on average over the coming year, more than two-thirds of reserves will still earn +0.1%, with a sizable additional share to earn 0%. And so, even assuming that the full proceeds of the BoJ’s asset purchases this year get recycled back into excess reserves at the central bank, on current plans the average interest rate to be applied on banks’ current account balances will be closer to +0.05% than the headline -0.1% figure.
If the BoJ continues buying Japanese Government Bonds (JGBs) from the banks, and banks recycle all of those proceeds as excess reserves at the BoJ, then the average interest rate on those deposits might edge below 0% in “about two years.”
And even that might not happen.
The BoJ also said that it would increase the amounts that earn 0% as balances increase due to QQE. So Daiwa concludes that the excess reserves at the BoJ might never “be subject to a negative average interest rate.”
Banks and other institutions need to hang on to some JGBs “for collateral and asset/liability matching purposes,” and the BoJ cannot buy them all. So now there is “a growing realization at the BoJ” that “the limits to further JGB purchases might not be too far off,” according to Daiwa:
Certainly, we would have doubted its ability to fulfill a larger target.”
So, the BoJ seems to have found itself between a rock and a hard place – up its target for JGB purchases and risk missing it, or introduce negative rates, threatening the achievement of even its current JGB purchase program. It is therefore trying to steer a middle ground, introducing a negative interest rate on bank reserves that isn’t really a negative rate at all.
And once the dust settles on the “BoJ goes negative” headlines and the details of the announcement are digested, the eventual outcome of today’s announcement may be simply to reveal the diminishing options the BoJ finds itself with.
It gets even more interesting, in terms of head fakes. Daiwa points out that “the pressure will remain on the BoJ to ease more.” That’s a pressure on all central banks. More free money, more asset price inflation, that’s what everyone clamors for. And that won’t go away. Central banks opened that can of worms years ago.
But that further easing, when it does happen, will come in form of negative interest rates not QQE, with the BoJ eventually pushing interest rates deeper into the negative. But there’s a conundrum: such a move may well have to come with a tapering of QQE:
In that respect, today’s announcement might be viewed as the first step to phasing in a new monetary policy framework centered on interest rates rather than one centered on asset purchases.
The idea that the BoJ could end its mega-QQE, after the Fed has already ended its QE, would put terror into the minds of those expecting a permanent money-printing Nirvana. And head fakes of NIRP won’t exactly assuage their rattled nerves.
QE came under fire from one of the world’s largest asset managers and investment banks. Read… Mega Investment Bank Suddenly Pooh-Poohs QE