Central Banks: Conflicting forces from low rates policy – AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that until negative news on Deutsche Bank hit the market, there was building strength in EM and commodity currencies and a weakening trend in the JPY and this developing trend experienced a significant setback on Thursday.

Key Quotes

“Deutsche Bank’s problems have intensified since the USA Department of Justice, on 16 September, made a claim of $14bn against the bank to settle its case related to alleged misselling MBS before 2008.  Deutsche Bank plans to argue for a much lower fine, but the risk is that it faces a bigger fine than it had provisioned for forcing the bank to raise additional capital.

European bank shares have underperformed this year in part due to the low flat European yield curve with negative rates, cutting into bank profit margins.  Essentially the same problem that has undermined bank share prices in Japan, and weakened overall financial sector company performance, including pension managers and insurance companies that traditionally invest in long-term bonds.

Since the BoJ introduced its negative interest rate policy on 29 January, it has used a tiered approach, so that banks are not paying negative rates on all of their excess reserves, to help limit the cost to banks from this policy.  Since 21 September, it has further moved to add so-called Yield Curve Control (YCC) to its policy to limit the degree to which its JGB purchases flatten the yield curve, to help improve the profitability of banks and other financial institutions.

These mitigation efforts by the BoJ have been at best mildly effective so far.  The bounce in Japanese bank share prices has been quite limited.  The yield curve overall remains quite flat with much of the curve, out to at least 10 year JGBs, still negative.  Nevertheless, the BoJ’s YCC may have provided some support to Japanese equities, and it might provide a framework for its monetary policy to be more sustainable and therefore more credible and effective.

The fall in Deutsche bank shares, spilling over to other bank shares and overall equity market, may place pressure on the ECB to also consider a policy of yield curve control.

Conversely, the same underlying factor that is contributing to bank woes, low bond yields, occasionally spilling over to broader risk aversion, at other times is contributing to stronger equities as investors hunt for higher-yielding assets.  As such, the equity market and other high beta assets have been buffeted by the conflicting forces emanating from extraordinary monetary policies in Japan and the Eurozone.”