Monetary policy has taken centre stage since the Great Financial Crisis in 2008. This has resulted in a tidal wave of liquidity into the financial markets.

Candy Floss Money

The exaggerated form of liquidity is “candy floss money”, a term coined by Financial Times to describe how “real” money can be spun into an inflated bubble, similar to the way a tiny amount of sugar can be woven to a huge cone of candy floss.

As a result of excess liquidity, financial markets have evolved from a “risk-on, risk-off” sentiment to one of “yield-on, yield-off”. Economic outlook matter less and yield considerations have a greater impact on the movement of capital within the financial markets.

Against this backdrop, the recent monetary policy stance by Bank of Japan (BOJ) to conduct a “comprehensive assessment” shine a torchlight into the effectiveness of monetary policy.  In this newsletter, we highlight three thoughts on the addiction to money printing by the central banks:

  • QE to ZIRP to NIRP
  • Tail-end of monetary policy sugar rush
  • Don’t let sugar rush turn diabetic
  1. QE to ZIRP to NIRP

For the past seven years, central banks have been cranking up the candy floss machine to print money in an effort to stimulate the economy. Monetary policies have evolved from QE to ZIRP to NIRP i.e. Quantitative Easing (QE) to Zero Interest Rate Policy (ZIRP) to Negative Interest Rate Policy (NIRP). With NIRP, negative interest rates have become the norm in developed countries. There are more than US$9 trillion of sovereign bonds with negative yields. These bonds are generating negative returns for investors willing to buy them.

  1. Tail-end of monetary policy sugar rush

The central banks appear to be running out of bullets after venturing into negative interest rates. The BOJ eased less than expected at its policy meeting on 29 July. It increased the size of annual ETF purchases from ¥3.3trn to ¥6trn and increased the total size of its US dollar fund-supplying operations from $12bn to $24bn, among other policy measures. More importantly, BOJ “will conduct a comprehensive assessment of the developments in economic activity and prices under “QQE” and “QQE with a Negative Interest Rate”” at its next meeting on 20-21 September.

The review of monetary policy is appropriate as BOJ is reaching its limits by running out of bonds to buy. It now holds over a third of the country’s debt and is projected to own 50% of its government bonds by 2018. The scale of money printing is reaching its limits.   Since the BOJ meeting, 10-year Japanese Government Bond has crashed with its worst four-day sell-off in 13 years. The yields have retraced from a record intraday low of -0.295% to -0.078%.

 

YTD chart of 10-year JGB

10 yr JGB

Source: Bloomberg

  1. Don’t let sugar rush turn diabetic

The excessive wave of money printing has led to a combination of a tidal wave of liquidity and the search for yield. Yield assets such as REITs and Telcos are among the top performing sectors this year with FTSE Singapore REITS Index and MSCI Asia Pacific ex Japan Telco Index generating returns (in USD terms) of 19.1% and 12.8% this year, outperforming MSCI Asia Pacific ex Japan Index returns of 7.5%. Investors are heavily positioned into these assets. As a result, cash is cheap and yield assets are expensive.

YTD chart of Singapore REIT Index (USD)

YTD REIT

Source: Bloomberg

However, valuations are lofty for yield assets with stretched risk-reward ratios. After currency hedging cost, yield pick-up between the US Treasury yield and German Bund yields have disappeared, after narrowing from 70 basis point at the start of the year. Even the pick-up for US Treasury yield over the Japanese JGB has narrowed to less than 20 basis points from 125 basis points at the start of the year.

The hunt for yield has resulted in the investors’ positioning for yield assets to be at the extreme end. This could lead to a steep sell-off if there is a “yield-off” scare as it did in May 2013 when Ben Bernanke proposed Fed tapering. This “yield-off” scare could come when investors begin to lose confidence in policymakers and rotate out of these expensive yield assets.

The monetary policy sugar rush is good while it last. Too much of it will lead to addiction and diabetic for the capital markets of the world. Monetary policy has clearly reached its limitations. It will be prudent for investors to take profits off the table for yield assets lest their experience turned bittersweet.

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