The annual report from the BIS warns of broader market turmoil as central bank stimulus is removed. If this occurs, the Japanese Yen is likely to recover.
Talking Points
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BIS Warns of Overreliance on Central Banks, Lack of Pro-Growth Reforms
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Japanese Yen May Recover as Post-FOMC Selling Evolves into Risk Aversion
The 83rd annual report from the Bank of International Settlements (BIS) released over the weekend spoke out against central banks’ “whatever it takes” approach to monetary policy in the aftermath of the global financial crisis, warning the extraordinary accommodation of recent years has bought time for structural reforms but is not a substitute for them. With that in mind, it called on the private sector to hasten balance sheet repairs, on governments to redouble efforts to achieve fiscal sustainability, and on regulators to reform oversight and ensure banks are adequately capitalized.
Perhaps most ominously, the BIS argued that the cost-benefit balance to continuously aggressive monetary stimulus is “inexorably becoming less and less favorable.” In this context, it cautioned that postponing the inevitable exit from the current ultra-accommodative policy regime makes doing so progressively more challenging. The report specifically cited the dangers of an increase in interest rates for public finances in countries where the crutch of “cheap money” has delayed budget reforms, saying a mere 3 percent rise in US Treasury yields across the maturity spectrum could inflict losses of $1 trillion on bondholders (excluding the Fed).
Price action seen last week in the aftermath of the FOMC monetary policy announcement seems to validate the BIS’ concerns. Fed Chairman Ben Bernanke said policymakers can conceivably begin to reduce the size of monthly asset purchases this year, with eye to discontinue them by mid-2014. This sparked a sharp drop in US Treasuries, with the benchmark 10-year yield racing higher to finish the week at a two-year high of 2.58 percent. Broad-based liquidation of positions relying on cheap QE-linked funding likewise prompted selling of European, Australian, Canadian and New Zealand government bonds, boosting yields there as well.
Japanese bond yields mark a notable exception to the jump elsewhere in the major economies, with the 10-year JGB rate holding steady even as others soared. That’s not altogether surprising: the very low-yielding JGBs are unlikely to have been a major beneficiary of QE-driven capital inflows when compared to higher-paying alternatives elsewhere in the G10 space, so post-FOMC liquidation is probably not a significant factor. This may explain the persistence of Japanese Yen weakness both last week and in overnight trade as widening yield gaps encourage carry trade interest. As we discussed last week, this is among the key factors drawing a distinction between the post-FOMC carnage and outright risk aversion.