Global Head of Capital Markets & Thematic Research
The Bank of Japan’s policy can be compared to a monetary tsunami: the bank is simply flooding the markets with liquidity, and the ripples are felt on all financial markets. The goal is clear: the bank aims to reflate the (Japanese) economy. The first wave of liquidity from Japan’s actions last week drove the Nikkei to a five-year high and the JPY/USD exchange rate to a temporary four-year low.
And the ripples are felt not only on the emerging markets’ bond markets, where yields declined, but also on the European and US bond markets. In fact, the recent six-month German government bond was issued at a negative yield and almost all euro-area risk spreads narrowed. Both developments are probably due to central-bank liquidity (not just from Japan) on the search for yields. (By the way, it is not only the usual central-bank suspects who pursue an expansionary policy: The People’s Bank of China does not hesitate to expand its balance sheet either.) Unfavourable US labour-market data were also swept away by the latest announcement, as was the deterioration in Spanish and Italian fiscal figures.
Interestingly, while the central banks are oozing money, inflation in the euro area dropped to its lowest level since 2010. Central-bank money does not necessarily drive consumer price inflation upwards (as developments in Japan since 1990 have shown); it may also result in asset price inflation and exchange-rate distortions. And that is what is at the core of the financial market crisis from the 1990s until today: Japan – the mother of all crises. It is therefore no surprise that some observers are already voicing concerns about a new bubble on the US housing market.
The fundamental pattern (“liquidity before real economy”) will remain in place for some time to come. From a purely behavioural vantage point, real economic and corporate data will time and again give rise to further price increases and spread-narrowings. If they do not, there will be interim profit-taking, and this will give those who have remained on the sidelines a reason to invest, too.