Yet again the IMF has downgraded their global growth estimates to 3.2 percent for 2016 and 3.5 percent for 2017. Their policy prescription is more proactive use of fiscal policy and structural reform in conjunction with already supportive monetary policy. Indeed a criticism of current policy is its over-reliance on central banks and that the prolonged use of QE and negative rates bring unintended consequences. Olivier Blanchard, now at the Peterson Institute in Washington, but formerly the Chief Economist for the IMF, said he is wary on the use of negative rates saying “I don’t like it, I think it interferes with the business of banks in ways that are very complex” instead “I much prefer what we now call regular QE.”
Increasingly, investors seem to doubt the efficacy of Japan’s policies. The IMF notes in its economic update that Japanese growth and inflation have been much weaker than expected; “Growth is projected to remain at 0.5 percent in 2016 before turning slightly negative to -0.1 percent in 2017, as the scheduled increase in the consumption tax rate goes into effect.” Thus, it will be interesting to see what the BoJ does at its April 27-28 meeting; adopting negative rates has driven bond yields out to 10 years into negative territory but it has also come with a stronger yen. Japanese officials may be trying to ‘talk down’ the yen but one can question how sustainable this may be increasing global scrutiny on competitive devaluation to try and boost growth.
The former BoJ Deputy Governor Iwata suggested that the BoJ would hit the limits of its bond buying program in 2017. Reports suggest the BoJ owned 34.5 percent of government debt in February and is projected to own 50 percent of the Government bond market by 2017; market illiquidity is likely to make further purchases challenging and increase market volatility. If the BoJ is hitting the limits on asset purchases then expanding negative rates are one of the policy options left: but the BoJ seems to displaying some caution making a ‘technical adjustment’ to the original announcement to reduce the number of accounts negative rates apply to but this is more a ‘tweak’ than a policy reversal at this stage. Although it is too early to judge, Japan’s March bank lending ex-trusts slowed to 2% yoy.
While the government is yet to backtrack on its planned consumption tax hike (from 8 percent to 10 percent next year) we doubt they will be able to push this through given the deterioration in the growth outlook. For example, the poor March Tankan survey highlighted falling inflation expectations, the Shunto wage round was seen as disappointing and generally growth numbers have been poor. Public debt at 250 percent of GDP is high but it is predominantly domestically financed (Japan has a positive net foreign asset (NFA) position) so further fiscal stimulus is a possible response. Unquestionably, there is more scope for structural reform. The policy risk is further steps into uncharted territory whereby debt monetisation is expanded in the sense of BoJ buying new government debt issued to fund larger deficits resulting in destabilisation, the loss of central bank credibility and investor confidence.
In a world of elevated debt levels our view is that QE is deflationary. When global aggregate demand is weak the risk is central bank easing becomes a game of competitive devaluation with no real winner; the danger is that QE is seemingly having better success in promoting risk taking in financial markets rather than stimulating growth in the wider economy as evidenced by the declining velocity of money. Estimates suggest there are close to USD7 trillion of bonds trading at negative yields. But corporate investment remains weak and for the average consumer wage increases are important drivers of confidence and increased discretionary spending: but even in the US, which has been performing better than Europe and Japan, US real median household income has declined since 2007.
The global backdrop remains extremely challenging which favours positioning in higher quality bonds with positive yields, especially value credits, where there is a ‘margin of safety’ (actual spread versus rating implied spread).