Jupiter Merlin Weekly: Playing monetary policy Whack-a-Mole
The Jupiter Merlin team discuss the continuing efforts of central banks to play monetary policy Whack-a-Mole, as this time it’s Japan’s turn to shock markets.
Kuroda announced that while not deviating from the strategy of managing the yield curve, the ceiling would be doubled to 0.5%. With other central banks having already been smoked out of their entrenched positions on interest rates and forced into a fighting retreat away from the notion that inflation was transitory, speculation is that Japan could also be forced to take further action and that the ceiling will be raised again. It’s a familiar story. Coming completely out of the blue, inevitably all major sovereign yields reacted in sympathy, rising sharply (the corollary of which is prices falling).
While digesting Japan’s news, investors took a closer look at the fine print of the ECB’s announcement last week when it too joined the Fed in the “higher for longer” interest rate club. Monetary conservatism is reasserting itself in Europe with the German representatives on the ECB leading the way. As the ECB steers a new course, markets are looking at the potential points of tension, much of which predictably focuses on countries with too much debt. At the forefront is the fragility of Italy. We have discussed this subject many times. Under the microscope again is the extent to which its banking system in particular is propped up by a plethora of artificial structures (with pithy, trip-off-the-tongue titles such as Targeted Long Term Refinancing Obligations) created by the ECB to give the illusion those banks have a secure capital base capable of withstanding the liquidity pressures inherent in a looming recession. Italian bond yields blew out again, and now match those of the eurozone’s traditional economic basket case that is Greece at 4.5% (incidentally, it is only a month since the UK was being compared unfavourably with Italy; our 10-year Gilt yield is now a full point lower than Italy’s).
The Italian banks will not fall over; the ECB will ensure it does not happen. But as we highlighted last week, in a financial system with all the design logic of Heath Robinson, eurozone monetary policy is a near-permanent game of Whack-a-Mole.
Rational behaviour is being restored. What concentrates the mind (or should do) is the realisation of how much debt was allowed to build up unchallenged when it was essentially free, forgetting that one day it might again carry a cost (and as we have argued forcefully in other columns, it certainly should carry a cost—debt is an obligation, not an entitlement); and given a decade of mediocre growth together with the significant fiscal drag and falling real earnings as unintended consequences of QE, what did it achieve? Monetarists, followers of Thatcherism and Reaganomics, might have long ago lost the argument of their cause, but the lazy consensus of liberal Keynesian economics has much to answer for!
On that provocative note, that really is it for this year. Happy Christmas!
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