ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Monday, February 14th, 2022. I'm Ash Benington joined today by Real Vision's own Weston Nakamura. Lots happening right now. Let's take a look at US equity markets.
It looks like S&P 500 paring some of the losses on the day to close negative 0.39% at 4,401, right at the 44-handle. NASDAQ dead flat on the day, 0.0%. Looks like it's off about a quarter of a percentage point closing out the day at 13,790. Dow Jones Industrial Average also off about half a point, Russell 2000 off a third of a point, settling at 2,222. Dow Jones Industrial Average settling at the day, 34,565 points.
Let's talk a little bit about what's happening out in the world today. The United States has evacuated diplomats and military advisors from Ukraine after statement from the Biden administration on Friday that a Russian invasion could come "at any time". Word out today those diplomatic efforts are still ongoing. European stocks closed the session down, Stoxx Europe 600, that's the broader European index, ending the session down 1.8%.
Russia is the world's second largest exporter of natural gas after the United States and a major supplier to European energy markets. Finally, St. Louis Fed President James Bullard, a voting member of the Federal Open Markets Committee, reaffirmed his view today that the Federal Reserve needs to "frontload their withdrawal of policy accommodation", adding "our credibility is on the line here". Weston Nakamura, any thoughts on today's news?
WESTON NAKAMURA: Yes, Happy Valentine's Day, Ash, first of all. You're welcome. Second thought on the news, regarding the Russia headlines, Russia-Ukraine headlines, they absolutely do move markets. This is very evident. If you actually look at this chart I have, there's two charts. The top one is intraday, I have it set to Central European time, but that spike up that you see, that is when you've got this headline shortly before US cash open, and you can see the Euro/Ruble cross, which is inverted on the chart to make it easier to visualize.
You can see that that slightly leads e-minis. And then the bottom half of that chart is a longer term a year-to-date thing. In the beginning of the year, obviously, the Euro/Ruble cross has really nothing to fundamentally do with e-minis until this geopolitical crisis started to really escalate and therefore impact markets, and you could start to see more of a tighter correlation.
ASH BENNINGTON: Let me just explain what we're looking at here. As the Euro/Ruble strengthens, meaning the ruble declines against the euro, you see, the S&P 500 e-minis as a proxy begin to sell off.
WESTON NAKAMURA: Yeah, not really as a proxy, it just means the Euro-Ruble basically--
ASH BENNINGTON: I mean the e-minis is a proxy for S&P 500.
WESTON NAKAMURA: Oh, yeah. Basically, if the ruble is weakening against the euro, it's generally investors that are getting bearish Russia, because Russia is getting aggressive and heading towards something that might look like a conflict or a potential war or whatever it might be. And then the reversal is a reversal of that sentiment.
ASH BENNINGTON: In the simplest terms, as investors perceive challenges in the Ukrainian region, you see this deterioration in equity market pricing, and that's also reflected in the cross pair between the euro and the ruble.
WESTON NAKAMURA: Yeah, more so. What I would say is that if you're looking for what-- especially if there's an intraday move like this chart, the top part of this chart, if you're looking for a reason for why the market is moving, it was at a Fed speaker's-- there's, well, a whole bunch of them this week, was it something else? Was it a piece of data? Was it a headline from Ukraine?
If you look at this cross rate, and then you just throw it on top of a live chart of e-minis or NASDAQ or whatever it might be, you can more or less see what's moving markets. And in this case, it is indeed these Russia and Ukraine headlines.
ASH BENNINGTON: Yeah, so not just the correlation, but also the directionality of the correlation.
WESTON NAKAMURA: Yeah. And if it's actually the relevant driver or not.
ASH BENNINGTON: Yeah. We should say also in the story about President Bullard, any thoughts on this notion of a sitting FOMC member stating that the credibility of the Federal Reserve is on the line if policy accommodation does not get withdrawn quickly, meaning rates rise quickly, or the Fed begins to lose credibility? That's essentially what Bullard is saying.
WESTON NAKAMURA: Yeah, I don't have anything specifically about that comment, but as a concept, absolutely. I said in my video on the Bank of Japan, which we'll get into a moment, but central bankers, the most important thing to them is credibility. It's their currency. Without credibility, they have nothing. Look at the CBRT of Turkey. If you don't have credibility, you don't have anything.
The reason that that's so important to maintain at all times is that if you do something with monetary policy, such as this, take this negative interest rate in Japan that's been there since January of 2016, that has been policy error evident within an hour of the announcement of it, yet they've kept it on this entire time.
The reason that they can't pull that out is because the second they do, they lose credibility. And if they lose credibility, whatever is immediately going to replace that failed policy, even if it's seen as failed policy from years ago, that's not going to work because you don't have any credibility. So, you need to maintain credibility. What Bullard saying is definitely right in terms of maintaining credibility.
ASH BENNINGTON: Hey, Weston, perfect segue into a point that I wanted to raise, which was your video last week, why global markets are addicted to the Bank of Japan. I know, we have a lot of US investors who are watching this who are not following the Bank of Japan as closely as you are, so just to tee that up for us, give us the context, explain the broader significance of the Bank of Japan to global asset markets.
WESTON NAKAMURA: Sure. For the full explanation, I'm not going to return to the whole video right now. But please feel free to take a look at it. It's on YouTube. And for everyone who has seen it and commented, and all that, thank you very much for all the support. It means a lot to me. Basically, what's going on is the following.
The Bank of Japan is a major central bank, it is the third largest economy in the world. For whatever reason, at a time when central banks are under the microscope, under a lot of scrutiny, the Bank of Japan is not part of the conversation at all. Everyone is looking at every single central bank as they should be, but the reason that that's very crazy to me is because the Bank of Japan is, in my view, the most significant of all of them.
And the reason is because at a time when global central banks are removing accommodative policy that's basically been in place for let's call it a decade, and they're basically removing it as if there's no consequences. They're going to hike rates, they're going to or expected to, or they're going to stop with their bond buying or whatever their method of accommodative policy is, they're one by one removing them. And that leaves the Bank of Japan as the only central bank that is actively still easing, not tightening, but they're still easing.
What implications does that have on global risk assets when you have just this one central bank that's left doing it? Can they do it? Will they do it? And what happens if they cannot or will not keep global asset markets in order as they have been accustomed to for the last 10 years? But either way, if this is the last central bank, major central bank that's still doing this, that's a heavy burden to carry. And the fact that nobody is looking at the Bank of Japan is baffling to me.
ASH BENNINGTON: Well, let's talk about that and talk about the policy mechanisms that are in play. I saw a statistic in your video that was really striking, which is that the BOJ owns approximately 135% of Japanese GDP on their balance sheet. By way of contrast, we've been talking about the nearly 9 trillion in US dollar denominated debt that the Federal Reserve owns, that is only 35% of US GDP on the Fed's balance sheet, you can see the series at WALCL on the St. Louis Fed Fred database.
Bottom line, this is like a significant, almost four-fold increase from where the US is. Give us a sense of the context for just how much accommodation the Bank of Japan has unleashed on the Japanese economy.
WESTON NAKAMURA: Sure, absolutely. The other reason that that's important to look at is because sometimes they'll just look at the nominal figure of the balance sheet size. And that it's meaningless unless you compare it against relative against the-- and so, by looking at it as a ratio to GDP, by far, the Bank of Japan is the most intensely aggressive in terms of their policy easing.
Brian, if you go to the purple charts, on Chart 1, this is basically just the chart of 10 Year JGB yield, and yield curve control, which is what I'm focusing on. Yield curve control is the most consequential and most radical policy of major central banks in the last half decade. The reason people don't realize that is because it's going on in the background. But just because it's going on in the background, it doesn't mean that it's not significant. And it certainly doesn't mean that--
ASH BENNINGTON: Let's explain what it is because the yield curve control the Bank of Japan is doing is different from what the Fed is doing here in their policy accommodation by keeping rates low. Give us the context for YCC.
WESTON NAKAMURA: Sure. What Bank of Japan has done is leading up to yield curve control, they have amassed a little bit under half of all JGBs outstanding, so they've already cornered the JGB market as it is. That sets it up for yield curve control. What yield curve control is, is literally self-explanatory, it's controlling yield curve. There's two components, there's the frontend policy rate, which is at minus 0.1. That's the negative interest rate that they did in January of 2016.
And then from September of 2016 onwards, what they started to do was they pinned the 10 Year JGB yield at around zero. And that around zero is, it's a very flexible figure up for interpretation of both markets and the JGB, but the way that they control the long end, the 10 Year, which is something that's unprecedented in modern central banking, what they do is they do one of two things, they buy JGBs, either by what's called a competitive auction, or a fixed rate operation.
Competitive auction is basically their standard just JGB buying. It's pre-announced, they say exactly what tenor, what the quantity is, what the date is, and they execute those buys at 10:10 am on the days that they're buying. The other one, the fixed rate operation is rarely used. That's when the Bank of Japan announced that they're going to step into the market, and they're going to buy an unlimited amount of JGBs at this specific tenor, at this specific price.
And if you have an unlimited printing press, theoretically, you have a wall of buying that caps yields to the upside. That's how yield curve control generally works.
ASH BENNINGTON: Weston, I know that there's some news on precisely this front that we're going to get to in a second here, but I want to bring this back for people who are listening to this who are not necessarily following macro policy as closely as you are. I want to give them the context for why these matters. Give us the sense for why yield curve control and monetary policy in Japan has an impact on global rates, first of all, and then second, to the meat and potatoes, how this affects US equity market investors, what the impact of rates in the US and globally has on US equity markets.
WESTON NAKAMURA: Sure. In chart 2, you'll see that this is the same thing. The 10 Year JGB with yield curve control. And then I've also thrown on top of it the 10 Year US Treasury yield. That's all that is. And what you'll see is that the 10 Year US Treasury yield seems to more or less, directionally, move in line with JGBs or vice versa. The significance of yield curve control is that-- just take the households for example, they're sitting on $14 trillion of cash, essentially. The majority of their assets are in cash, hence the deflation.
Their cash hoarding culture. Same with the corporates, same with asset managers, they're holding a ton of cash, they have a ton of firepower, and they're in need of yield, because the Bank of Japan is pinning the 10 Year yield, the long end at zero. There's no yield to get in Japan. What that does is it forces Japanese investors to go overseas, like to the US Treasury market and buy US Treasurys and collect yield.
Therefore, when the Bank of Japan caps yields in on JGBs via yield curve control, essentially what they're doing is they're doing indirect yield curve control on the US Treasury market and even on European sovereign rate markets as well, because Japanese investors are buying US Treasurys and all that, and that caps US Treasury yields.
ASH BENNINGTON: By the way, that's a big idea, the idea that one central bank, the Bank of Japan, could be effectively anchoring rates globally, because of the cash flow coming out of the country as Japanese investors seek a return on investment, seek yield, they're pulling down rates elsewhere. This is a big concept.
WESTON NAKAMURA: Yeah, and it's something that I think is completely overlooked by a lot of people. This is exactly why it's such a big mystery to people who look at the 10 Year US Treasury yield and say, oh, how could it be under 2% with the 7-handle on CPI or because the Fed is doing this? The reason that those things don't match up is because the US Treasury market is not just a US-based market. It's a global market, there are global investors, all with their own needs, and whatever it may be, and Japanese investors will unconditionally buy US Treasurys, because US Treasurys are, first of all, they're always safer than JGBs, because Japan has the highest debt in the world, 250% debt to GDP. So, even with US Treasury, or US Congress debt ceiling theater, all that kind of stuff, even with that, it's still safer than JGBs.
ASH BENNINGTON: The question you're answering here, Weston, is this idea, why is it that we see inflation rising in the US but you don't see the massive take off in yields, a decline in price in US Treasurys? You're saying it's because of basically, central bank policy action coming out of the BOJ which is causing these hot cash flows here into the United States creating demand, and therefore suppressing yield.
I believe you pointed out in your video that the largest foreign buyer of US Treasury debt is Japan, and it is by a wide margin. I think it's 1.3 trillion relative to about a trillion dollars coming from China. These are significant, significant cash flows.
WESTON NAKAMURA: Indeed. They're exporting their monetary policy, they're exporting this demand for yield. If you go to the third chart, the third chart is basically, this is how the Bank of Japan controls yield curve, this is the two ways that they do it. The left side is the regular buying schedule. The right side is this fixed rate operation where they buy unlimited, they offer to buy unlimited capped yield curve.
And the fourth chart, this is the most recent, like what's going on right now. Right now, the Bank of Japan has yield curve control. They have upper bounds set at 25 basis points. 25 basis points is where the Bank of Japan is going to step in theoretically and actually and offer to buy an unlimited amount of JGBs.
ASH BENNINGTON: This is at the 10-year duration?
WESTON NAKAMURA: Correct. And you could see, again, this is what the 10 Year US Treasury yield also thrown on top of it. And you can see that that 25-basis point level, basically, the 10 Year JGB yield was right there. Then last week, literally as I was making the video, this is what happened.
But that level wasn't really breached, but the BOJ came out and made a very unprecedented announcement in which they announced a fixed rate operation in which they're going to buy an unlimited amount of JGBs. But they did that in advance. They said that on Monday, today, we will be conducting a fixed rate operation to buy an unlimited amount of 10 Year JGBs at 25 basis points.
What's crazy about that, or what's very unprecedented about that is that first of all, when the Bank of Japan conducts these fixed rate operations to buy an unlimited amount of JGBs, they do so right on the spot. During the daytime, if yields get too high, they'll step in out of nowhere, and they'll just offer to buy unlimited amount of JGBs. And that cap yields.
I've never seen them do it in advance, especially days in advance. That was a very peculiar thing. Another crazy thing about that, too, was that they're offering 25 basis points, which is below market rate. They're offering to buy below market rate. That to me says, and I don't know for sure, but the reason that they're doing that is because I think that what they're doing is a defensive move where they are essentially--
Sometimes what happens is when they announce a fixed rate operation, that announcement in and of itself, the threat of the announcement or the announcement itself will threaten the market and the market will just back off from it. And they won't have to conduct an actual fixed rate operation in which they actually get filled on these buys and sells.
ASH BENNINGTON: And this is pre-COVID because this is the new news here. This is the update coming off of your last week's piece.
WESTON NAKAMURA: Correct. What they did was ahead of a three-day weekend at 6pm, they announced that on the following Monday at 10:10 am, they're going to conduct a fixed rate operation at, and the rate was set below that current market level. My takeaway from that was that they believe that come Monday, today, that the 10 Year JGB yield would be yielding far higher than 25 basis points. They basically saw a bond market crash coming in the near term. And this was before the US CPI was announced and all that too.
ASH BENNINGTON: And as you pointed out in your video, I believe, or you're pointing out on Twitter, this happened essentially at the moment of the coin toss during the Super Bowl. If you wanted to bury something, you couldn't have picked a better time to do it. Something I don't want to bury though, Weston, because it's exactly on point with what we're talking about here.
There's a clip from a show that aired on Real Vision today called, How the End