全球央行分化与主权债务隐忧：日银加息博弈、英国QT权力让渡与法国利差危机

Hello my friends. Today is September 19th and this is Markets Weekly. All right guys, so last week of course the big news was the Fed. We already have an entire episode on that and for those of you following this channel, you guys would have known weeks in advance that the Fed was going to hike. Now last week though, we also had some interesting news from other central banks. So today, first let's talk about the Bank of Japan hiking to 1.25% and yet still disappointing the market. Secondly, let's talk about the Bank of England. Now the Bank of England did not hike but they did do something pretty interesting when it comes to their QT program. So in a sense they are similar to the Fed allowing their government to decide the maturity structure of the debt and seemingly reverting to I guess a more neutral position when it comes to the bond market. And lastly now many of you have been looking for a debt crisis. Now, honestly, I don't think you're going to find that in the United States, but maybe, and I mean maybe, you might find that in France. So, let's talk about what's happening in the French debt market.

All right, starting with Japan. So, as many of you know, over the past few months, the yen has been depreciating pretty rapidly, and it's pretty obvious why. Now the Bank of Japan even though they've had inflation above target dropped a little bit but still moving up they have kept interest rates to be very very accommodative. Now the slowness in their hiking cycle in part has to do with the fact that they dealt for decades of deflation disinflation and are hesitant to do anything that is too restrictive and in part is because Prime Minister Takiichi is widely perceived to be putting pressure on the Bank of Japan to not hike rates. She is willing to accept a weaker currency. Now, Secretary Basson has been mentioning that's been complaining about the weakness of the yen and there are reports suggesting that he also is putting some pressure on Japan to hike rates. But in any case, it was widely perceived the Bank of Japan would have hiked rates and they did to 1.25%. Again, guys, here at the Fed, we're like 4% and the Bank of Japan is at 1.25%. And inflation in Japan really isn't that low. So the Bank of Japan is definitely definitely slow.

Now this is something that the market anticipated and was something people hoped would give some stability to the Japanese yen. But the thing is the way that the decision was announced. Now if you look at this excerpt from the decision, you can see that even though they hiked rates, there were two people who dissented and those two people were Takichi appointees. So it's just like the US when not too long ago you could have Trump appointees basically consistently voting for say well dissenting for 25 or 50 basis point cuts. So there's something similar going on over there. The government is putting pressure on central bank. Now the market didn't like that and it perceived that further tightening was going to be maybe a little bit slower than the market perceived and so you saw the Japanese yen basically weakened notably.

Now there were rumors of another rate check. So the government trying to do things to stop the yen from becoming too weak. But the fact is that the interest rate differential between the dollar and the yen is just wide. And unless that narrows a bit, it's very difficult to see how the yen could strengthen. Now the market continues to price in about two more hikes from the Bank of Japan in the next 12 months. And that should be supportive if not for the fact the market is actually pricing in an even more aggressive hiking cycle from the Fed. Now looking at the expectation of interest rates as proxied by the 2-year yields in the US and Japan, you can see that although the Japanese 2-year yield has risen in anticipation of more hikes, the US 2-year has simply risen more. And in fact, the market is surprisingly pricing in three more hikes from the Fed even after the past week. So again, both central banks are hiking, but the market is thinking that the Fed will out hike the BOJ. And so that argues for further dollar strength, yen weakness. The good news though is that the Japanese bonds, the long end in Japan is well is better behaved now than in the past. One of the reasons people thought that Besson cared about the strength of the Japanese yen was that the weak yen was spooking long-ended JGBs and that of course being since sovereign debt is a global market that of course has been impacting long-dated treasuries as well. Now even though the yen is still not seemingly on the precipice of continued weakness the long JGBs have been better behaved and so that is a positive development.

Now the second thing that I want to talk about is what's happening in the Bank of England. Now the Bank of England had their meeting but they did not hike last week. There is a global energy shock the UK is of course vulnerable to this but according to the Bank of England they're not seeing second round effects. So that is to say even though energy prices are rising they're not seeing that bleed into say things like wages they don't see the inflationary impulse bonding to other aspects. So so far they're upbeat on that. What was interesting though is that they did a tweak to their QT program.

Now recall over the past decade central banks around the world especially during the pandemic bought a whole ton of sovereign debt trying to add accommodation to their economies. After the pandemic, QT was basically a global thing. Central banks trying to shrink their balance sheet, get ahead of inflation. Now, something that is special about the Bank of England is that although they did QT, they did it in a more aggressive fashion compared to say the Fed. The Fed just let their portfolio passively run off, but the Bank of England actually actively sold some of their securities. So, it was a much more aggressive form of QT. Now, gilt yields over the past couple years of course have trended higher. We did have that notable kerfuffle in the gilt market after Liz Truss announced her budget and you know she's doing her tours in her podcast in part blaming the Bank of England. Maybe she's right. I don't know. But in any case, the UK gilt yields have been steadily rising and Bank of England is changing how it's doing QT by doing I think two things actually. One of course is that they are revising their QT schedule to be less aggressive which makes total sense when you have elongated yields keep going higher and higher and maybe some degree of instability.

And the second tweak they're doing is much more interesting and that is they're still doing outright sales but they are selling only to the government. That is to say that when they're doing their QT sales they sell to the government and how will the government finance that? Well of course the government will sell gilts. Now the difference of course is that in this circumstance the government controls the maturity structure of the debt rather than the Bank of England. Now if the Bank of England were just selling say 10-year gilts because they want to do QT shrink their balance sheet then that's them deciding how much duration the private market receives. Now by just selling only to the government then the government will decide how it wants to finance those purchases. The UK Treasury could for example issue say three-month gilts to buy long-dated gilts from the Bank of England and thus from their perspective would have control over the maturity structure of the debt that the private sector faces. So this is very similar to what we hear from Chair Warsh where one of his arguments for shrinking the balance sheet at the Fed is because he thinks that the government should control the maturity structure of treasuries that the private sector faces and not the central bank. Now during the QE era the Fed would just go and buy all this long-dated debt and thus they would take that decision away from the US Treasury. Now when you have a smaller balance sheet that decision goes back to the US Treasury and Besson as we all know has been issuing primarily in the short end or at least to a greater extent than before. The UK it seems like they're following a similar template where the Bank of England is shrinking their presence, reverting who decides the maturity structure of UK gilts back to the Treasury. And so it seems like this is a global movement where the government of course is going to be more prominent and maybe just taking back power that was initially theirs and the central banks continue to play a smaller role primarily toggling with the overnight rate which of course shapes the expectation of the path of policy. So I thought that was interesting.

Last thing we want to talk about is of course what's happening in France. Now I think this chart would tell you everything you need to know. So this is a chart of French OATs, so French bonds as a spread to German Bunds. Now in Euroland because every European government has their own bond market but the German bonds are perceived to be the safest. So they are considered to be the standard of European sovereign debt the safest basically. And you can see that the spread between French OATs and German Bunds has been steadily widening. Now it's around 100 basis points, highest it's been in like 14 years. Now Europe is different from the US in that these European countries are not monetary sovereigns. They don't have their own printing press. They are bound to the euro which is controlled from the ECB which they have representation on but don't fully control. So you're never going to have a sovereign debt crisis in the US because at the end of the day the Fed can always buy it all. Right? That no one's just going to let their own bond market implode. That's very dumb. Fed can always buy it all. Now in Europe though, that's different because France doesn't have its own printing press. They are bound by the euro. So what's going to happen then if they have some kind of sovereign debt problem.

Now the origins of this rise in French OATs as they're spread to Bunds, it's pretty obvious. Now if you look at the French budget deficit, it's pretty wide, right? They have a fiscal deficit of about five or six percent. Comparable to the United States. However, in the US, the US does have stronger growth. They have that AI boom going on. A lot of people have a lot of optimism and it does seem like to be a pretty important technology. You don't really see that nearly to the same extent in France. And of course, the US has a printing press which France does not. And so troubles in the budget will have to manifest in higher spreads in the sense that they're kind of like a corporation because the corporation also does not have their own printing press. Now common ways of addressing this of course would be to spend less and raise taxes like higher revenue. Now it's really hard to spend less in France as we all know. We had for example yellow jacket protests a few years ago. If you try to cut benefits just a little bit, it's very very common in the political culture there to go on strike and then nothing works and it's very difficult to do any reforms. It's also difficult to raise taxes because taxes are already very high. We've talked about this a few times over the past, but I asked AI to make this chart so that you have a good comparison about the after tax or the effective tax rates of someone who's making a million dollars, a million euros, a million CAD. So on the one hand you have people who live in the United States in a no income tax state like Nevada or someone looking in Las Vegas for example for a million dollars their effective tax rate is in the high 30s. In someone living in Paris though making a million euros their effective tax rate is over 50%. Right? So what that is is the government taking most of your money. That's a very very high effective tax rate and when you're already paying such a high effective tax rate it's hard to go even higher. Over the past few years you've had people like Gérard Depardieu famous French actor basically leave the country, a lot of them go to places like Belgium, less likely to go to places like Russia, but you know people can just leave especially when you're in Europe and you have so many competing jurisdictions around you. So higher taxes is probably not available to the French government. And if you can't raise taxes, you can't print money, you can't cut benefits, you're in big trouble. And you see that in the Bund-OAT spread and of course upcoming political elections where you could potentially have big changes in government where Marine Le Pen comes to power and she's going to take the country on a different direction and that is going to I think maybe cause some investors unease as well.

So, where you want to think about potential sovereign debt issues, you want to look in Euroland, not in the US or or even in Japan, actually. So, one interesting news I saw the past week is the Greek finance minister telling the German finance minister, you guys should implement financial reforms. For those of you around the European debt crisis a decade ago, it was these small countries like Spain, like Portugal basically getting bullied by the core European countries telling them to do reforms which they had no choice but to do which totally imploded their economy but did put them on a sounder fiscal footing. Now they're turning around and telling Core Europe that they have to do the same thing. Core Europe of course is in a different position because they have more political power. So I don't know if they'll follow that but totally interesting developments that is actually something worth watching going forward.

Now the last thing that I'll mention is that I think that over the past few weeks okay starting after next week we'll have we passed September OpEx the market is going to have more freedom to move but I think it's going to be driven primarily by what happens in the Middle East. So if you look at oil prices and you look at geopolitical developments, it really does seem like we are at a pretty dangerous position. Whereas if we could have some kind of positive resolution in the Middle East, honestly S&P 500 is going to go to 8,000 in the blink of an eye. Yields will come down significantly and it will be tremendously tremendously bullish. However though that will require the president taking a loss and although I was thinking that maybe you know we could just have an easy way to end this market goes up helpful in the midterms and so forth. It is also possible that the president decides that in order to quickly end this war he has to escalate. That would be a really bad thing for the markets. You could have oil surge, yields surge in market. So I think we should pay more attention to what happens in the Middle East in deciding for the next few weeks, what happens before the midterms.

And after the midterms though, there is a possibility that you could have a blue tsunami where the Democrats take the Senate and the House. And then I think what we're hearing right now from many of the leading candidates is people that are a bit more wary of the AI data center buildout and a bit more pro-AI model regulation. And so that political turn could have big impacts on the AI trade. So that's what I would focus on in the coming weeks. All right, talk to you guys next week.