Fra Deutsche Bank
According to DB’s Dominic Konstam, now that the benefits QE “have run their course”, it is time for the next, and far more drastic step: “the ECB and BoJ should move more strongly toward penalizing savings via negative retail deposit rates or perhaps wealth taxes. With this stick would also come a carrot – for example, negative mortgage rates.”
Here is the big picture unveiling of what is coming next from Deutsche Bank’s Dominic Konstam, who is also buying the Treasury long end hand over fist:
- The G3 central banks all stood pat, continuing the move away from the beggar-thy-neighbor paradigm. However, the adverse market reaction to the BoJ’s inaction suggests that the benefits of QE (or QQE) in its present form might have run their course.
- It is becoming increasingly clear to us that the level of yields at which credit expansion in Europe and Japan will pick up in earnest is probably negative, and substantially so. Therefore, the ECB and BoJ should move more strongly toward penalizing savings via negative retail deposit rates or perhaps wealth taxes. With this stick would also come a carrot – for example, negative mortgage rates.
- Until then, bank NIM compression will continue to drive elevated demand for dollar-denominated assets, which manifests itself in suppressed UST term premia and wide cross-currency bases.
- What this means for the US is that policy rates and longer bond yields are unlikely to go up until global growth accelerates materially. Until such time, it is critical for the Fed to continue to relent, allowing real yields to keep falling while breakevens rise and nominal yields remain roughly static.
- If the Fed were to turn hawkish, there is perhaps even less scope for long-end yields to rise as breakevens would likely collapse on policy error fears.
Some of the troubling detail:
QE as implemented in major economies since the crisis has operated through two shocks: a demand shock whereby real yields are forced lower through lower nominal yields and static – or even falling – breakevens, and a shock to inflation expectations, whereby real yields ultimately continue to fall but due to rising BEI and static to lower nominal yields. In the case of the Anglo-Saxon economies, the demand shock quickly gave way to the shock (higher) to inflation expectations and actually allowed nominal yields to rise, if fleetingly.
The second shock, to inflation expectations, has thus far remained stubbornly elusive in Europe and more so in Japan, and ephemeral in the Anglo-Saxon economies. That said, this dynamic appears to have re-emerged in the US post Fed relent and has been an important driver of the recovery in risk assets and, more generally, the easing of financial conditions.
This week’s BoJ announcement disappointed, and as a result the yen appreciated sharply. This outcome does not bode well for the future efficacy of QE, at least while that is the primary policy tool in use. Breakevens have been drifting lower and real yields have been drifting higher since last summer. In other words, financial conditions in Japan are tightening, suggesting the need for more stimulus. However, the BoJ already holds a significant proportion of the assets that would be available for purchase, and the gains from additional QE activity – higher breakevens, lower real yields, and a weaker yen – are likely on the margin to be fleeting. It appears that the markets doubt the BoJ’s willingness or ability to carry on with larger and broader asset purchases, or worse yet they do not believe that such asset purchases will have their desired stimulative effect
Further QE should be viewed as an experiment in real time, where the point of inquiry is the level of real or nominal yields at which credit will begin to expand more strongly with loan-to-deposit ratios increasing. What seems increasingly clear to us is that this level is likely at negative yields, and probably substantially so. If this is true, it would suggest to us that the equilibrium level of rates in the economy is probably negative. This in turn would strongly suggest a significant re-think to short-rate policy. In this case, central banks should move more strongly toward penalizing savings, rather than just the institutions that “house” those savings – the banks. This would mean allowing significantly negative retail deposit rates or perhaps even wealth taxes. With this stick would also come a carrot – one example being that while deposit rates penalize savings (the whole point), banks might also pay borrowers to buy houses via negative mortgage rates.
In short, the real central bank panic is about to be unleashed; who will suffer? Why everyone else. And should wealth taxes really be imminent, we foresee a lot of “boating incidents” in the immediate future.