This week we are going to have such a parade of central bank decisions on the menu: #RBA, #BOJ, #FOMC, #BOE, and #SNB 😵💫
All eyes will surely be on the #BOJ and the #FOMC. I do expect they will play “good cop bad cop” with market emotions. 🤭
The #BOJ is surely trying to drag its feet until the very end on whether or not they will decide to hold reference rates for one more month or finally lift them back to positive after 17 years, ending the (shameful) era of “free money” when everyone forgot that borrowing should actually come at a cost.
I wrote already last week in “THE #BOJ DILEMMA – SAVE #JAPAN OR THE GLOBAL #STOCKS BUBBLE” why this upcoming #BOJ decision will be so crucial for many people’s futures and not only from an investment perspective. Personally speaking, I think the #BOJ will try to find a last-minute excuse not to lift rates that are now expected to hit 0.25% by the end of 2024.
If you think the #BOJ hiking rates will be a “nothing burger,” I am sorry, but I have bad news for you. First of all, the impact will be on the whole $JGB curve, not only on the short-term part, triggering a yield increase in 10 years yield towards the 1% “soft ceiling” already set by the #BOJ in 2023. For those with memory issues, I would like to remind you that when that (unexpectedly) happened in 2023, it created panic across the market with yields shooting straight toward 1%, forcing the #BOJ to intervene and buy $JGB in the market, injecting a wave of freshly printed $JPY into the market that contributed to sending the FX rate above 150 against $USD, triggering direct intervention selling reserves to avoid a tsunami of margin calls (with the US treasury not only turning a blind eye to this manipulation but likely even helping in the process). Be prepared to see something similar happening on Tuesday if #BOJ finally makes a move.
Wait, isn’t $JPY supposed to appreciate if rates go up? I am afraid not, for 2 reasons I highlighted many times:
1 – Debt servicing costs for #Japan will rise, requiring the #BOJ to print more $JPY to pay for higher interests on #Japan’s gigantic debt.
2 – Rates worldwide will rise due to a global repricing through swap spreads, likely widening since so far they have been held down by the #BOJ’s (reckless) QE policy.
What I described will reverberate across the world financial system, increasing funding costs for institutions that, through the decades, leveraged themselves to an unbelievable degree exploiting the $JPY carry trade. A trade that now will be under significant pressure on two fronts: cost of funding increase and $JPY depreciation. I know that a $JPY depreciation, in particular, should be in theory benefiting the carry traders, but paradoxically because of the currency hedges in place against a $JPY appreciation, this won’t happen as I explained a long time ago in this post: TwitterX.
Banks, in particular, will risk seeing any significant stress in managing their funding because of all of this. Not only will they be required to post additional collateral on their hedges, but they will experience an increase in the cost of funding while the value of their non $JPY (mainly USD-denominated) assets will lose value due to an increase in rates. This will happen to institutions holding razor-thin capital compared to their assets because through the years they favored #stocks buybacks and dividends, pushing to maximize their Returns on Equity, rather than increasing their capital buffer to manage situations like this. Logically, we will see more and more institutions having liquidity problems and with even the #BTFP not available anymore, it’s going to be a difficult task to fill the liquidity holes in their balance sheet without selling assets at a market value much lower than the book value they still showcase in their balance sheets. What a mess, really.
Shadow banks, that hold even less capital, will have to pull off incredible acrobatics to not fall into insolvency very quickly because they hold even less capital than banks do and leveraged themselves beyond what they were supposed to do. Like it or not, banks lending to non-bank financial institutions is currently the biggest item in most of the major banks’ books worldwide.
It looks like the #BOJ can trigger the perfect storm and sorry to be blunt, but that’s the reality. This is why I am saying the #FOMC this week will likely be in firefighting mode to avoid a dangerous domino of liquidity and insolvency crisis across the financial world.
Jerome Burns on Wednesday will have the near impossible task of convincing the financial world that the #FED is still on track to cut rates this year despite #inflation in #US now roaring back and on track to be officially above 4% later this year (unofficially it is obviously well beyond that already). What kind of rabbit can Jerome pull out of his hat this time to kick the can down the road again and avoid a disastrous scenario during a #US election year? Here is what I expect after stretching my imagination:
1 – The #FED will announce an “operation twist” under which they will increase the buying of short-term T-Bills vs walking away from supporting longer-term US treasuries. This will help them to maintain money market rates under control and avoid them skyrocketing, creating havoc in banks’ funding market while fighting the resurgence of higher inflation expectations. Clearly, this will increase the paper losses in “hide till maturity” banks’ books, but as long as they can avoid a liquidity crisis, this problem will remain manageable as it has been so far.
2 – The #FED will loosen the requirements of their discount window, increasing the basket of assets eligible to be posted as collateral to receive liquidity. Hopefully, the discount window will not remain in just its name and they will lend liquidity against collateral market value contrary to what they did with the #BTFP aberration (that was effectively a temporary capital injection to bail out struggling banks).
The stage is set for a hell of a show this week. Be sure the #FOMC will do everything in its power to make sure the #stocks bubble doesn’t pop. However, they are walking a finer and finer line while they are running out of options and I don’t rule out that, like in 2008, they will be forced to ask Congress to approve a new TARP (this time in the trillions) before the elections.