Japan's Sell-Off

by Michael J. Howell30. May 2013 19:58

A 15% drop in just a few days focuses the mind. Is Tokyo's rally bust already? Not a chance, in our view. Nerves have been twanged by the sharp jump in JGB yields and associated steepening of the Japanese yield curve. But a steep yield curve is exactly what QE and liquidity policies should deliver. America since 2008 is a clear case in point, but the evidence is overwhelming and true throughout history and across geographies. In fact, this is how bond markets work. Forget all the talk that Central Banks push down yields by buying bonds. In a micro sense they do, but economics and finance are more about macro events. A steeper yield curve reflects fatter risk premia and fatter risk premia on bonds are the very reverse of slimmer risk premia on stocks, or should be if the monetary stimulus works. In short, bonds always sell off and enjoy these fatter risk premia when investors expect a return to 'better times'. Therefore, a steep yield in Japan, as in the US and Europe, signals coming economic recovery. Sell bonds, buy stocks. This is an unexpected opportunity for equities.

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Global Liquidity Climbs A Peak

by Michael J. Howell17. May 2013 11:01


Global Liquidity rose again in April 2013 to a GLI reading of 65.2 ('normal range' 0-100), or the highest since October 2009. Of more interest, is the fact that without the drag from a tight Eurozone and sluggish EM, the Global Liquidity Index (GLI) would probably be over 75.



Gold: There is No Conspiracy!

by Michael J. Howell19. April 2013 14:02

The recent plunge in the US dollar gold price is unsettling but it reflects no dark forces and no sinister conspiracy by Central Bankers. The reason is the strong US dollar, and this strength maybe unusual for this stage of the business cycle, but it is driven by underlying liquidity forces. Specifically, when our PSL index exceeds the Fed CBL index the dollar soars. This is true now, with a strong Fed outpaced by even stronger private sector flows underscored by corporate revenues, household recovery, renewed shadow bank lending and shale oil cash. In short, its economics not politics that is the problem for gold.

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Latest GLI March 2013

by Michael J. Howell19. April 2013 13:57

Our Global Liquidity Index (GLI) jumped to 64.5 in March 2013 (normal range 0-100). A large increase in Japan Central Bank liquidity and continued gains in US private sector liquidity more than offset another slide in Eurozone liquidity. EM liquidity remained low, although cross-border inflows into EM picked up a tad. Our data story still supports a strong US$. It also warns of Eurozone Crisis.

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Japanese QE is Fifty Fifty

by Michael J. Howell19. April 2013 13:53

We are big fans of the new BoJ QE policy. Latest weekly data confirm things are happening. Our measure of net liquidity provision jumped to Y57.7 trillion and the annualised growth in the Monetary Base leapt ahead by 54.3% at an annualised 3-month rate. Fifty and fifty is not an bad start.

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New Report: Japan's Great Experiment

by Michael J. Howell18. April 2013 12:22

Report published April 15th 'Japan's Great Experiment' analyses the effects of huge injections of cash into a banking system that is uniquely able to re-lever and can already satisfy Basel III capital requirements. The outlook remains very bullish for Japanese risk assets.

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New Global View Published "The End of Emerging Markets???"

by Michael J. Howell4. April 2013 18:28
Special report looks at the three important headwinds facing EM in 2013-14 - (1) China (2) Japan and (3) the US. Does this explain the loss of momentum in EM capital inflows and the tailing-off in domestic monetization?

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New Globl View Published "Eurozone: Shuffling Towards the Abyss"

by Michael J. Howell4. April 2013 18:21
Special report on skidding Eurozone liquidity and the Target2 imbalances suggests that ECB are getting it wrong again. Lower Euro ahead!

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Target2: The New QE .... and QT

by Michael J. Howell4. April 2013 11:24


To solve US funding problems, the Fed has willingly and unambiguously taken the dysfunctional US wholesale money markets and essentially put them on to its balance sheet. The ECB has indirectly, unconsciously and, possibly, unwillingly done the same through the Target2 system. The Target2 balances measure the cumulative balance of payments disequilibria between Eurozone economies. More accurately they underpin these disequilibria because Target2 is an automatic lending system that prevents the need for the deficit economies to adjust.


This was not, of course, how the system was designed. No one truly foresaw that the wholesale funding markets could disappear for so long and that the ECB would be compelled to finance these funding needs for years. Consider an example. Say, a Spanish bank loses deposits for whatever reason to a German bank – capital flight or trade. Normally, the Spanish bank would either correspondingly reduce its loan book (and investments) or replenish the funding by borrowing indirectly from the German bank through the wholesale money market. Credit concerns now rule this out, so instead the Spanish bank effectively borrows from the ECB (via the Bank of Spain). The German Bank can now choose either to increase its overall lending; increase its reserve balance at the ECB or reduce any borrowings it has from the ECB. The actions of Spain keep the Spanish component of the Eurozone monetary base intact; the actions of Germany will increase the German monetary base if German banks build up their reserves, or leave it unchanged, if the banks pay off ECB loans. Commercial forces likely push the German bank to maintain its funding and build up reserves, thus increasing the German component of the Eurozone monetary base.  Adding these bits up, the total Eurozone monetary base should rise and fall pari passu with the Target2 balances.

The actual data tell a staggering story: over the period since the Euro started in 1999, the correlation between the Eurozone monetary base and the size of German Target2 balances (both measured in Euros) is 0.027; from 2009 this jumps to 0.511; from 2010 to 0.623 and since 2011 to 0.787. From 2012 onwards, it hits a whopping 0.954, showing that the two series move virtually step-for-step. They are indistinguishable. Therefore, the latest fall in Target2 and the associated drop in the Eurozone monetary base shows a inadvertent tightening of monetary conditions. We have been warned.

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Cyprus: illiquidity vs insolvency

by Michael J. Howell30. March 2013 11:34
Banks are often insolvent: they are less often illiquid. Insolvent banks can survive: illiquid ones cannot. The key Cyprus banks and probably many Spanish banks are insolvent, but only the Cyprus banks are currently illiquid. The gift of more liquidity from the IMF/ ECB has been made conditional on depositors suffering a 'haircut' on their deposits. Many think this unfair, but is it? Cyprus banks allegedly lost most by investing in Greek debt. Unlike most other Western banks they were predominantly funded by retail deposits rather than wholesale funds. In other words, Cyprus is more an old-fashioned case of poor lending/ investment decisions than a question about lack of wholesale funding. Moreover, it is not systemic, or too big to fail. It is Europe's equivalent of the Barings failure.Therefore, the IMF/ ECB can afford to take a tough line. On the other hand, it is a fine-line being drawn here, and one that sees to rest on the source of bank funding. Spanish banks have also made poor lending decisions, but they are bigger, lately more dependent on wholesale funding and, more importantly, more likely a systemic threat. The ECB is funding these and other banks either directly through its balance sheet or indirectly through the Target2 balances. Therefore, strictly in pure banking terms the ECB are probably correct to force a haircut on Cyprus although the size is up for debate. What is less clear is why they are not doing the same for other Eurozone banks and, moreover, why the funding playing field is so uneven and ill-thought out. It tells us that (surprise, surprise) all decisions are political, and they are reactive. The air of crisis management hangs like a pall over the Eurozone. We remain skeptics, not about the integrity of the Euro, but about it's level. Future funding crises seem inevitable, and hence the Euro must drop more.

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