Is It Different This Time?

One of the apparent conundrums of US Fed money printing in the current cycle is lack of headline inflation, at least as measured by the CPI. Certainly the CPI calculation itself is open to debate in terms of whether it is accurately depicting the cost of living in the US. But in bigger picture context, alongside quiescent headline CPI, the US credit markets have likewise not priced in meaningfully accelerating inflationary pressures. Although the very act of currency debasement academically connotes rising inflationary pressures, the US Fed has received a free pass in the current cycle so far as prior period predictions of a hyperinflationary fireball have fallen well short of the mark.

Meaningful to global economic and financial market outcomes ahead will be the Bank of Japan monetary extravaganza of a generation that lies directly in front of us. Will Japan be so lucky as to have little to no headline inflationary impact while printing historic amounts of money? Or could it be different this time relative to the US monetary and inflationary experience of the last four to five years? Although not given much recognition amongst the high fiving over recent Japanese equity market levitation, there is one critical difference between the backdrop against which the Fed has operated compared to the landscape the BOJ faces.

If we step back and take a bit of a bird’s eye view of the current cycle, a keynote fingerprint character point of Fed monetary policy is that it has played out in the direct aftermath of a US credit cycle bust. In terms of the timing and sequencing of potential cycles of inflation, this is important to keep in mind. In one sense what the Fed has sponsored with its own balance sheet growth has simply offset in magnitude balance sheet contraction in other sectors of the US economy, probably none more dramatic than the damage we’ve seen done to the asset backed markets over the last half decade.

assetbacked041213

Key point being, the BOJ ahead will be operating in no such environment of immediate prior period credit contraction. The credit contraction, if you will, in Japan already occurred long ago. So if we think about Japan as a total system, BOJ money printing will be expanding the total balance sheet as there is no offsetting individual sector balance sheet contraction of consequence.

As a bit of a visual proxy, let’s have a look at Japanese bank loans outstanding since the early 1990’s. Bank loan contraction bottomed eight years ago. And as you can see, on a rate of change basis, year over year Japanese bank lending is in positive territory where it has spent precious little time if we look across a number of decades.

japanesebankloans

As of the moment, the US and Japan find themselves in different credit cycle bust aftermath time sequences. And so we should expect similar inflationary outcomes under historic monetary policy experiments? I think not. Of course the second large and differentiating factor so far is relative currency movement. We all know what has happened to the Yen over the last five months. The US dollar never experienced this type of decline anywhere over the current 2009 to present cycle. Bottom line being, we should not be surprised to see a quite different outcome with inflationary pressures in Japan than has been the recent case in the US under similar monetary extremes.

A few final comments. First, nominal inflation would really pick up in Japan if economic acceleration accompanied by meaningful wage gains were realized. This remains an open question mark on both fronts. Political leadership has advocated for higher wages in Japan, but corporate profit margins will be the ultimate determinant. On the economic front we are already seeing fallout from BOJ policy not necessarily favorable. Much as has been the case with US Fed actions for years, investors have already been trying to “front run” the BOJ. With the announcement from the BOJ targeting the lengthening of balance sheet asset maturities, investors bought long maturity JGB paper funded with sales of short maturity paper. This modestly drove down longer maturity rates, but drove shorter term yields up. Lending rates in Japan are keyed off of shorter maturity (two and five year) yield levels, so this is not a plus for lending, and by implication economic expansion. It’s more a prescription for stagflation.

Finally, as investors we need to think about and monitor whether actions of the BOJ could transmit inflationary pressures globally, much as the actions of the US Fed have done, especially in emerging markets. We already know financial asset inflation, especially stock prices, is a key target of BOJ policy. Without question, additional Japanese capital moving out of the Yen will impact global equities. But credit markets are the key watch point as they will price in potential accelerating inflationary pressures long before equities. In the US, it’s the TIPS implied inflation breakeven rates that I continue to monitor. The US Fed began its latest round of monetary largesse at the highest implied breakeven rates of the current cycle. We’re just not that far from breaking out to “new highs” not only for the current cycle, but for the prior decade.

tipsbreakeven041213

For now, the grand monetary experiment continues. We simply need to be careful of the high level of complacency that has grown up around the impact of monetary policy on inflationary pressures in developed economies. The impact of BOJ actions will be global in nature as well as unprecedented. Stay tuned.

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