08/11/2017 - The Roundtable Insight: Yra Harris And Peter Boockvar On The “Pottery Barn” Global Bond Market And The Insanity Of Central Bank Policies

In this week’s episode we are joined by both Peter Boockvar and Yra Harris. Peter is the Chief Market Analyst with The Lindsey Group and the Co-Chief Investment Officer for Bookmark Advisors. He runs an economic newsletter product called The Boock Report which offers great macroeconomic insight and important updates on economic indicators. Yra is an independent trader, a successful hedge fund manager, a global macroeconomic consultant and has been trading foreign currencies, bonds commodities and equities for over 40 years. He was also the CME Group Director from 1997-2003.

FRA: Today we would like to talk about a few things, perhaps starting with quantitative tightening. Peter is the first to come up with that term. You’ve written recently about that, Yra, in terms of the relationship of that to steepening curves, the 2-10 spread on the yield curve. Also with the possibility of buying bank stocks; there was a question from a reader. If you want to talk about that?

YRA HARRIS: In following Peter’s line – everything I’ve read from Peter and what he’s talked about – is that the next move by the Fed will be the commencement of quantitative ease before we get the next Fed Funds increase. The dynamic will be very interesting to watch. I know what Peter talks about hinges on that, and now everyone else is talking about Draghi and his upcoming appearance at Jackson Hole. I know Peter’s probably more prone to think that he’s going to lay something out to the market, but I’m not quite there yet. I view the ECB and what their final destination is different from the Fed’s destination.

It was interesting on July 26 when everybody was talking about the five year anniversary of Draghi’s famous ‘Whatever It Takes’ speech. When he said it which was actually July 25, I was on CNBC with 5:30 Chicago time, I’ll never forget it, and Steve Liesman was interviewing me, and I said, “They’re going to have a very big problem in Europe” because all the 2-10 curves, the two year yields on the peripheral bonds were 7% and the curves had flattened dramatically from over a hundred-some odd basis points down to 70, and I said it was all coming because of the pressure. They couldn’t fund anything even in the 2-year market. So it was a bear selloff in two year debt across all of sovereign Europe. I said, they got a problem, and while we were on talking about this, Draghi announces his ‘Whatever It’ll Take’, no taboos. So I find that interesting, but when they quote that speech he said, the mandate was also the preservation of the Euro.

I hang a lot on that; I think Draghi hides behind the veil of inflation now, even though inflation targets for whatever they’re worth – and how they came up with the 2%, that’s a whole other show, I’m sure. But that discussion means he’s got something else. The thing we’ve kind of talked about is that he wants to pile on as much assets onto the ECB balance sheet. I think his end game is that he’s going to do what the EU finance ministers and leaders don’t have the strength to do, and create a Eurozone bond. I think that’s what his plan is, and I’m more reticent to thinking he’s going to give us a wink and a nod to some type of Boockvar QT. That’s what I’m looking at.

Going back to the steepening, if the Fed embarks on this we ought to see a steepening. If the ECB doesn’t pull back and the BOJ doesn’t pull back, then as Peter’s talked about, markets are broken so we’ll never get a real signal. The signaling mechanism truly has been broken by central banks. I tongue-in-cheek use Colin Powell’s phrase that ‘it’s a pottery barn bond market now’ cause central banks have broken it so therefore they own it. That’s where we lie, but we should see a steepening.

FRA: Peter, your thoughts? You were the first to identify that term and what could happen by the Fed QT – quantitative tightening.

PETER BOOCKVAR: I think that long term treasuries are caught in this tug-o-war between the downward dragging yields because of the moderation and inflation and mediocre growth at the same time the Fed’s raising interest rates and there’s a natural inclination to flatten the curve. You have that one hand, and speaking of a mediocre economy we have the very interest rate sensitive auto sector that’s essentially in a recession. On the other hand you have this potential pull upwards as QT begins and maybe Draghi starts buying less bonds on a monthly basis. We’ve seen some days some relationships, some days not, of a move in overseas yields dragging or suppressing upwards downwards US yields.

So if all of a sudden Draghi does say, ‘you know what, starting January we’re trimming our purchases from 60B to 40B Euros, and then three months later it’s gone to 20B, and by the middle of next year it’s gone to 0, we’ll still reinvest but it’ll be over by the middle of next year’, then I don’t think the 10 year German bund yield is going to be 42 basis points. I don’t think that the Italian 10 year is going to be sitting around 200 basis points. I think that the European bond market is tinder for a major selloff if Draghi actually follows through with the 2018 tapering plan that takes him down to near nothing. I can’t imagine the US Treasury yield, regardless of what inflation and growth stat is going to sit there, also 225, if the German 10 year is all of a sudden 1%.

If we rewind the tape back to 2015, over a two month period the German 10 year bund yield went from 7 basis points to 100 basis points in two months. It definitely helped to drag up US interest rates. There is going to be that push and pull back and forth, and we saw when Draghi hinted at the tapering last month, and we saw in eight trading days, the German 10 year yield went from 25 basis points to 54 basis points and it helped to drag up US rates. How this plays out in terms of process obviously remains to be seen, but I’m more worried about US yields based on what the ECB is going to do rather than what Fed QT is going to do.

A combination of them both could be dangerous for longer end bonds, but I think the ECB may be more of a dominant lever in determining that.

YRA HARRIS: I agree with that wholeheartedly. If the ECB were to announce quantitative tightening of any sort, I agree with that. That’ll happen. I’m just not expecting Draghi to go that route yet, but if he does I think we’ll have a tremendously volatile move in the long end of the curve especially. When the Fed talked about ending QE, when they first started QE everyone said, ‘oh these curves, they’re going to flatten it’, and then when they were going to end it the initial thing was to steepen. And people were going, ‘yeah, you’re removing a buyer from the markets’, which everybody who’s been sitting there it’s almost like Greenspan putting it to the stock market. If you pull away the reaction is going to be dramatic because so much risk has been put on for very little premium. Risk premiums are ridiculously low across the board. When Greenspan comes out and talks about his bubble, first off all I don’t give much credibility to it because he might be right, but if I wait for it I’ll probably be broke. It’s a famous Keynes line.

If Draghi ejects all, I will be pinned. I haven’t wanted to be. You’d like to take a European in August, but that becomes so critical if he does deliver that. I think we’ll see a tumultuous move, I agree with Peter, on the long end of the curve. Across the board, and it’ll be led by the Europeans. I know that Gundlach was out talking about, oh, German debt is mispriced, but I would argue that French debt is more mispriced, being only 25 basis points richer than the Germans. At least the Germans have a bid to it automatically because of the repo market. It’s the most desirous high-quality liquid asset, so you always have a little bit of a bid. The French, it doesn’t serve as great a purpose. And certainly not the Italian and certainly not the Spanish. It would really cause some interesting moves in the debt market. From a trader’s point of view, I hope he delivers it. When I analyze it and think about his endgame, possibly which is the creation of a Eurozone bond, I’d be surprised to hear that from him. But if he does deliver that, I agree with Peter. We will have a wild ride in the global bond market.

PETER BOOCKVAR: Central banks generally – and certainly the ECB – believe in what they’re doing. They really believe that negative interest rates has been a good thing. They really believe that essentially nationalizing the European corporate bond market and the region’s bond is a good thing. As long as they continue to believe in what they’re doing, they’ll continue to do it to the greatest extent. Draghi is running up against some logistical challenges where it’s some sort of taper is the default rather than by his choice. It’ll be an interesting hoop that he jumps through.

The program is scheduled to end in December so they have no choice but to lay out a game plan for 2018 for the purpose that the current one is going to expire so they’ve got to renew it in some way and in some fashion. By doing it in September, we’re laying groundwork in August, he’s at least giving the market enough time to say, ‘now we know what the 2018 plan is.’ Basically what Yra is saying is that the plan can continue as is. Instead of saying, ‘we’re just going to extend it a year’, which is very possible, they have to tell us something because it’s supposed to end anyway, even though we know it’s not.

YRA HARRIS: Someone ran a very good article yesterday, talking about the amount by just rolling over. Even if they ended QE, but didn’t start shrinking the balance sheet, it’s still a huge amount of money cause of the duration they have on, when they really started buying this stuff. There is a shortage, and they’re already in violation of every rule that was written about this, because the capital key which is supposed to be sacrosanct? They can’t meet it because there’s just not enough German paper. They could not ever meet that number. It was a design flaw to begin with. Typically in the EU, they circumvent whatever rule there is anyway because the European Court of Justice already determined that the primary thing is the preservation of the entire EU project, which means whatever makes it sustain itself. That seems to be their legal binding principle from the European Court of Justice. So even though in Germany when some of the more stalwart money people had brought cases, they’ve lost in at the German high court because they seem to follow that same principle.

We are getting to crunch time. You can keep pushing and kicking the can down the road but as Peter rightly says, we’re getting to crunch time. They’re going to have to tell us what they’re going to do. I think the biggest surprise is – I’m sure Peter will agree with this – if they said, and this will be a huge surprise, that they were going to start following the rule with the BOJ and start buying actual equities. That would really rock the market; we’d probably see the Euro drop 5-6%. Then they know there’s no end to this and they have no end plan and they’ll keep searching for assets to keep pumping money into the system.

PETER BOOCKVAR: That would uncharted territory. That, I think we’re not going to do because that is a logistical nightmare, that is a political nightmare. At least when you’re buying sovereign bonds you should get paid back, but you start buying equities? I can’t imagine the Bundesbank crossing that line.

YRA HARRIS: Like I said, that would be the greatest surprise there is, especially in August before the German elections. You might hear that in October but you won’t hear it until Merkel is comfortably enthroned upon the Chancellorship of Germany. That would really rock the system.

FRA: But isn’t that what the Swiss National Bank has been doing in terms of financial alchemy buying international bonds and equities?

PETER BOOCKVAR: It’s been extraordinary, and even before they got there they cut short term deposit rates down to minus 70 basis points. Just to emphasize, negative interest rates are just a tax, and someone has to eat it. Whether it’s the bank that eats it or they pass it onto a consumer, it’s confiscating wealth. I call it a weapon of mass confiscation. That’s all it is. So you layer on the Swiss National Bank becoming its own hedge fund, that becomes dangerous. Now the Swiss Franc, outside of today’s rally, has been weakening.

Let’s take this a step further. Let’s say Draghi lays the groundwork for tapering and follows through when the Euro goes north of 120. Well the Swiss Franc will weaken further, reducing the need for the Swiss National Bank to be so aggressive, and maybe that leads to some time in 2018 either reversing negative interest rates or manipulating their currency less and you could see where global monetary policy is potentially heading. At the same time the Bank of Japan is in a subtle taper, they’re only on track by 50T Yen instead of 80T because they’re focussing on yield curve control and we know Kuroda is leaving in April and maybe whoever replaces him is going to change tact. We heard from an ex-deputy Bank of Japan member a few days ago – Owada – who even talked about 10 year yield curve is stupid, because you’re destroying the yield curve for banks, let’s just out the 5 year and give them some steepness of the curve. Well you see a sharp selloff in 10 year, 20 year, 40 year Japanese paper, it’s not going to just be in Japan, it’s going to filter through interest rates throughout the world. I guess we’re sort of paining a scenario where you can get a long term rise in interest rates globally and not for a good reason. It’s for the reasons of the reversal of extreme monetary policy that’s sort of blowing up and central banks are losing control of interest rates on the longer end, which is probably their biggest fear.

FRA: We were under the impression that the Swiss National Bank was doing this for the reason of lowering the currency rate, especially in the Euro-Swiss cross in terms of what that is, but in July that cross rate was making 30 month highs and even then the Swiss National Bank was still buying. Are there any other reasons that they might be continuing to do this?

YRA HARRIS: I just think that they don’t have an action plan. This has been going on and going on because if I’m running the bank, they don’t have to announce it, they’re not under the same mandates as the Fed. I would argue that when I do a weighted average of what they spent to buy in Euros, because the biggest intervention was buying Euros because that’s what they purportedly wanted to do to control the cross rate from appreciating too much in favor of the Swiss, but their average price for all the interventions that they’ve done? They have to be making money on their Euro end, which is unbelievable. You would think that they’d start entering the market. It is interesting that we saw last Friday a substantial move corrective in the Swiss. I thought, hmm, maybe the bank is in. But it didn’t have any staying power. I thought maybe they were coming in and selling their Euros to buy some Swiss back, but now we’re seeing it today – the cross has moved a big way. We’ve gone overnight from 114.5 down to 112.5. It’s a sizable move, but that has to do with the “safe haven” status of the Swiss in the time of Tweetmania from the president and chief, which is ramped up global tensions. So you saw some move there.

We’ll see what that does, but the Swiss… it begs the question, do any of these central banks really have an end to this? It’s really interesting that the Fed went that route, but of course Yellen gave us the ‘relatively soon’ comment in the FOMC in the last statement. ‘Relatively soon’, I’m not sure what that ‘relatively soon’ means. Peter, I have to agree with him, it’ll probably be in September, that’s what relatively soon means. I was hoping it’d be August just so that from a trader’s standpoint I could see some of the action, but markets are too thin and it’s probably right to hold off. This is what the Swiss are telling me. What do you want? This is what your objective was. Now you’ve gotten there. Even though as we learned, the Swiss did intervene with 20B Swiss of new purchases in July, that just came out on Monday morning. We got to see that. That helped push it, but that wasn’t an astronomical amount cause they’ve done that much, but the movement of 4-5% in that cross rate over the last 2-3 months has been very severe and you would think that if they really had an exit strategy they’d be using it at this time. If everybody wants to buy Euros, then sell them Euros. You’ve got them to go and you can unwind some of this position. But they don’t seem to be doing that, so it really causes the question, what is the real objective?

PETER BOOCKVAR: The analogy I give is, to make war analogy, this is like Vietnam for these central banks. Rewind to the mid-60s when the war first started, it was gung ho and we’re going to win and cutting rates and QE and all this, and all of a sudden they realize they’re not really hitting their objectives. Inflation is below their target, growth is not accelerating, let’s just do some more, let’s just send in more troops. And that’s wasn’t enough so let’s send in more troops. And all of a sudden they realize that the war is being lost and they’ve got a full army but they can’t just pull out because the place will collapse. So Nixon wins the presidency in 1968 on okay, we’re going to get out of this war, and the war didn’t end until 1975. It seems like this is sort of what they’ve gotten into.

Just to add on what Yra said, let’s just say they all achieved their objectives. Let’s just say the Eurozone CPI goes to 1.5-2% and the BOJ is successful in generating higher interest rates. Well then what next? You can be sure bond yields won’t be where they are right now; they’d be much higher. The central banks have to get out of what they’ve done. If they create the next recession, if they create the next bond market implosion, was it really all worth it? They’re only good at getting in, and I can’t imagine what will happen if they reach their objectives or now try to get out. There’s no foresight. If you’re a company executive, if these central bankers were company executives, they would’ve been fired ages ago. No director would allow a CEO to remain in place, doing the same thing year after year after year with no results. As any government official, since there’s not really much accountability, they unfortunately get to do what they want, with the consequences to be felt later.

YRA HARRIS: It’s such a great analogy, and fits so well with David Halberstam’s great book of that period, The Best and the Brightest. When you listen to financial media all day and read the papers, they view that every central banker is the best and the brightest. Well, we saw the mess that they’ve got us into, the best and the brightest so to speak, with their models. Of course, those were also rational actor models, the same we’re seeing today in North Korea because the post-WWII period has been built on rational models. We won’t have a nuclear catastrophe because the actors are rational. Which is what economics is based on, and their economic theories and the modelling is based on rational responses. Those are the assumptions that all these models make, that consumers investors savers, everyone do things rationally. We certainly learned that in 2007. Peter’s allegory with the Vietnam War is right, we’re doing more, more, more because they don’t know. Of course the fallback for policy makers, as Peter points out, is counterfactual. I can’t argue with counterfactual, but you’ll be gone when everybody has to unwind this. It’s like Jack Welch running GE – it was great until the classes he built to withstand the 2007-2007 got tested and we see the outcome of GE today. It’s a stagnant, do nothing stock that’s a stagnant investment.

There’s so much yet to play out. That’s why the Swiss model is very interesting. If anyone should be extricating themselves, it should be the Swiss. They’ve purportedly done whatever they needed to do, they’ve been successful, and they’ve made nothing but profits and the world has accepted it. We’ve talked about it on this show plenty of times, it still boggles my mind because I’m still trying to figure out who in their right mind purchases Swiss Francs. Who’s the buyer?

PETER BOOCKVAR: Imagine what happens with them is, they sit around their table at their office at the Swiss National Bank and say it’s time to start backing away, and then all of a sudden you see the Swiss Franc rally and then what do they do? Then it becomes, forget about Vietnam, it becomes Afghanistan. Pull out and the bad guys are going to fill the vacuum, and then we’ve got to get back in again. They’re just trapped; they’re all trapped and they’ve trapped themselves.

YRA HARRIS: I agree with that 100%. And their language is the same – when you listen to Draghi, it’s like he’s just quoting from the FOMC statement. And the Japanese? It’s longer but it’s the same sell. And now Peter talks about it too: this yield curve control, this YCC, has been an absolute disaster because it was meant to steepen the curve. The Japanese curve is at 16 basis points, far from steep, it’s very flat. They’ve failed on every metric, and the currency really hasn’t done anything because of turmoil in the world and of course huge Japanese repatriation of money whenever they so desire because they have so much. They’re like Britain in the 1800s; they’ve got so much money invested all over the world that any time they decide to bring it home it boosts the Yen up.

PETER BOOCKVAR: You have the Japanese Bank TOPIX index, which if the banks were the transmission mechanism for monetary policy, and it’s up to the banks to increase lending and jumps start the economy, well the Japanese Bank stock index is 20% below its peak of 2015.

YRA HARRIS: I know, because I own the individual ones. Between the dividends, it’s been okay; it was a parking spot for me. They’ve had a few ups here and there, but there’s no way that’s a success because those bank stocks would be extraordinarily higher. If you look at the 20 year chart you would gag. If you look at it over 30 years you’re not close to even, and there’s nothing in sight. You look at everything the Bank of Japan has done – disaster. The JJB market is the second largest debt market in the world after the US, and there’s days it doesn’t trade. Imagine that; it does not trade.

PETER BOOCKVAR: There was an article the other day that the Japanese 10 year JJB trades at about 900M a day. The US around 7-11 year traded at 80B a day.

YRA HARRIS: They’ve trapped everyone with them. Now they own so much stock. It was interesting, I was listening to Jamie Dimon talk about how he buys Japanese stocks because the government pension and investment fund, cause they kind of follow their lead because they’re doing all this work behind quality companies, but they’re in a race with the BOJ. The BOJ is buying so much equity that in 4-5 years they would own 70% of the ETF market. What is that? It is absolute insanity and the Swiss show us there’s no way out. They don’t even know how the end the insanity.

Which leads you to where the trading situation is: the markets are very low, volatile, and people are getting paid to sell their premium and that’s what scares me more than anything. It’s not just risk parity traders like AQR and Bridgewater, it’s everyone that follows them buy, because as their models crush the volatility in the markets, everyone’s forced into a short situation. I think there’s so much more risk out there that if equity markets started to correct for whatever reason, and the bonds went with them. For a while last year we had equity markets dropping with bond yields rising, so that was like death for them. I harken back to long term capital – when everyone thinks they know the risk, it’s far bigger because of all the people who are copycatting and mimicking that trade.

FRA: One last question: if we see balance sheet shrinkage by the Federal Reserve and QT, could that result in increased monetary velocity?

PETER BOOCKVAR: That’s a great question. Considering that QE has resulted in the exact opposite, I think eventually. I don’t think immediately. I think that asset price bubble will be pricked when QT begins, along with maybe future rate hikes, but it won’t be until the expansion after the next recession that we’ll get that. If what Bullard said was any indication, and he’s a non-voting member, is in the next recession the Fed will put themselves back in the same hole. They’ll cut rates back to zero and they’ll start increasing the size of their balance sheet again, hoping and praying for different results. The question is whether next time around, the market tolerates that. You’d think a lot about QE is psychology. And we always hear about, oh I have no place to put my money, this and that, but QE1 QE2 QE3 because a lot of that money went right back to the central bank and excess results, a lot of the market reaction was psychology. If you get reverse psychology because people realize, oh that central bank put is much further out of the money than I thought, you get this decline in asset prices. The US economy in particular, the only thing keeping it out of recession is the consumer. Capital spending is defunct, yes trade has picked up a little bit, but it’s predominantly the consumer. Consumer spending is also dominated by middle to upper end, and if you get a decline in markets for example, that could change psychology and that alone could put us in recession. The velocity story may not be sold again until the next recession, but that alone may be dependent on how the central bank responds to that, and if they just continue with the same old tools, thinking they’re going to get some sort of different results, then maybe it won’t be reviving any time soon.

I think the next rate hike will be determined by how the market responds to quantitative tightening of September. If the market’s very nonchalant with it and doesn’t really respond and we get to that December meeting, I think the Fed’s going to raise interest rates again because they’re going to be looking at the employment situation in terms of labor markets being tight and anecdotal evidence in terms of wages popping up here and there and the difficulty in workers. Regardless of what you think of the Phillips Curve, it doesn’t matter because the Fed believes in it. Now if the market has a hissy fit or a tantrum after QT begins in September, they’ll obviously not be raising in December. The irony is that the market can rally itself into another rate hike, or it can sell itself off away from another rate hike. I guess it’s pick your poison, then.

YRA HARRIS: I think that’s right. And to follow it up, Richard, with your question, I know if you start down that path, and nobody has a timeline for when it’ll happen, you put all that money back to work into the collateralized repo market, this may fall right in your face and for all the inflation that everyone said wouldn’t be taking place? You might get some real velocity to this money you haven’t had before because it’s been sitting tart. Again, it’s theoretical and we’ve never been here. There’s a lot of theoretics to it and I want to see. I’m with Peter. That’s why I can’t wait for them to start shrinking it just so we can start to test it. Anybody who’s a scientist, you gotta put these theories to work. Let’s find out what’s going to happen. What scares me about the central banks is that they’re so afraid of going down some exit strategy that that’s what’s probably the most unnerving for me now.

Transcript by: Annie Zhou <a2zhou@ryerson.ca>

LINK HERE to download the podcast in MP3


Today’s Topics Covered:
• The relationship between Quantitative Tightening (QT) and steepening bond yield curves
• Possible volatility moves in the European bond curve if the European Central Bank (ECB) intends on announcing a QT policy
• The Swiss National Bank’s (SNB) purchases of international bonds and equities and the possible consequences of doing so
• The state of the Bank of Japan (BoJ) and the possible consequences of their current economic strategies
• How the Japanese Government Bond market is fairing in comparison to the United States
• The possibility of a balance sheet shrinkage by the Federal Reserve (FR) and what positive or negative outcomes may arise

Quantitative tightening, a term first identified by Peter Boockvar, is a policy in which the Federal Reserve uses to minimize bonds and shrink their balance sheet. Peter and Yra shed light on the relationship between QT and 10 year bond yield curves. Peter explains that long term treasuries are caught in a tug of war between the downward drag in yields because of natural inclinations to flatten the curve and the potential pull upwards as QT begins and bonds are bought less frequently. If the ECB announces QT then there will be a volatile move in the curve. Peter explains that there is a direction central banks are following in which there will be a rise in global long-term interest rates because of the reversal of extreme monetary policy. This outcome will gradually make the central banks lose control of interest rates.

They then discuss the questionable strategies of the Swiss National Bank to control the EUR/Swiss Franc cross rate. At first it was assumed that the SNB was using aggressive monetary policies in order to lower the EUR/Swiss Franc cross rate, but in July that cross rate was making a 30 month high while the SNB was continuing to buy. Yra went as far to question the actual existence of an exit strategy by the Swiss, “..but the Swiss… it begs the question, do any of these central banks really have an end to this?”. He argues that the SNB initially started off by trying to control the cross rate, but now they do not know what they want to do next or how to do it. He also makes an interesting point on how they should be making money on the euros they purchased and that they should be entering markets. Peter agrees with Yra and adds that central banks seem to only be good at getting towards their objectives, but they are not great at planning exit strategies. He explains that a Director for a commercial bank would be let go if he did not produce any results, but a government official does not face the same consequences. A government official can do as he pleases and not worry about detrimental future consequences. Yra states, “When you listen to financial media all day and read the papers, they view that every central banker is the best and the brightest. Well, we saw the mess that they’ve got us into, the best and the brightest so to speak, with their models.”

“Negative interest rates are just a tax, and someone has to eat it. Whether it’s the bank that eats it or they pass it onto a consumer, it’s confiscating wealth. I call it a weapon of mass confiscation. That’s all it is.” – Peter Boockvar

Peter also gave an insightful analogy comparing the SNB with the U.S. government during the Vietnam War. He explains that when the war started in the mid-60s, the U.S. government was overzealous in their pursuit to defeat the North Vietnam armies. In relation to the SNB, they too felt overconfident in their strategies and began cutting rates and using quantitative easing tactics. During the Vietnam War, the U.S. government realized that they were not progressing and decided to send in more troops. Just like the U.S. government, the SNB was not hitting their inflation target and growth was not accelerating and so they were increasing their amount of purchases. The U.S. Army continued to ramp up their reinforcements to Vietnam and eventually realized that the war was being lost and that they could not pull out of Vietnam because the place would collapse. He notes then noted that after Nixon won the presidency in 1968, the Vietnam War still did not end until 1975. He explains that the SNB has gotten themselves into a similar situation where they have already done so much damage to themselves that it cannot be so easily undone.
Peter also makes a great insight on how the SNB trapped themselves in a potentially disastrous situation. He describes a possible scenario where the SNB begins to back away from their tactics, but the Swiss Franc begins to rally. In regard to this scenario he states, “what do they do? Then it becomes, forget about Vietnam, it becomes Afghanistan. Pull out and the bad guys are going to fill the vacuum, and then we’ve got to get back in again. They’re just trapped; they’re all trapped and they’ve trapped themselves.”

They continue by discussing the poor state of the Bank of Japan and the Japanese Bond Market. Yra states that everything the JCB has done is a disaster and now the Japanese government bond market is the 2nd largest debt market next to the United States. He adds that there are days where the Japanese government bond market does not trade. Peter also adds that the Japanese 10 year government bonds are trading $900 million a day while the U.S. market is trading somewhere around $80 billon each day. They both agree that Japan and Switzerland need to figure out better policies and strategies to combat against potential recessions in both economies.

“The BOJ is buying so much equity that in 4-5 years they would own 70% of the ETF market. What is that? It is absolute insanity..” – Yra Harris

Lastly they discuss the possibility of an increase in monetary velocity if the FR is able to shrink their balance sheet through the use of QT. Peter believes that QT will eventually allow for the FR to shrink their balance sheet and the current asset price bubble will pop along with possible future rate hikes. He speculates that this will not happen until the expansion after the next recession. When asked if the market would thereafter tolerate quantitative easing he argues that the market reaction to QE is revolved around the psychology of the U.S. public. Depending on what tools the FR uses this time around will decide how the people react which affects the effectiveness of QE. Peter emphasizes his belief by stating, “If what Bullard said was any indication, and he’s a non-voting member, is in the next recession the Fed will put themselves back in the same hole. They’ll cut rates back to zero and they’ll start increasing the size of their balance sheet again, hoping and praying for different results. The question is whether next time around, the market tolerates that.”

Summary by Daniel Valentin, email address Daniel.Valentin@Ryerson.ca

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.