Richard Koo Has Some Bad Advice For The Bank Of Japan

Richard Koo is the brilliant Nomura economist who developed the framework of a "balance sheet recession" to characterize periods where private enterprises seek to reduce debt, rendering monetary policy largely useless, and thus requiring aggressive fiscal stimulus.

As such, Koo has not hopped on the Abenomics bandwagon, which places a heavy emphasis on the Bank of Japan engaging in stimulus.

The BOJ's stimulus has so far caused the stock market to surge, the yen to fall, and even long-term Japanese bond yields have had some big up moves, and this is what concerns Koo.

In his latest note, he warns that the Bank of Japan needs get out in front of inflation worries, and state that although it's targeting 2% inflation, it won't tolerate hotter inflation than that.

What can the BOJ do? To begin with, the Bank and the government could make it clear that they are targeting a 2% rate of inflation but at the same time, they will not under any condition tolerate a significant overshooting of that rate.

The Bank of Japan has built up an enviable record as an inflation fighter over the past 30 years and in the process won the public’s trust. Accordingly, I think such a declaration would still carry a lot of weight. By stating that they will not accept an overshooting of the target, the Bank of Japan and the government could reassure the markets that there will be no plunge in the yen and no bouts of uncontrollable inflation.

I think the risk of a sharp rise in long-term rates will also be significantly reduced if the BOJ can successfully communicate these points to the market. The yen’s rapid decline—which contributes directly to inflation—and stocks’ sharp rise in recent months has raised the possibility of such an overshooting. I think it would be appropriate for the BOJ to consider adjusting the pace of easing going forward in response to these unexpectedly quick improvements.

I think it is also important for the Abe administration to dispel the perception that its scenario for economic recovery is heavily dependent on BOJ policy by placing greater emphasis on the second and third components of Abenomics. If the government is seen as relying excessively on monetary policy at a time when everyone recognizes that the second and third components are essential for a longer-term recovery, the whole enterprise could be stopped in its tracks once monetary policy is perceived as having run up against the wall because of a rise in long-term rates, etc.

One of the beautiful things about Abenomics is the perception of recklessness. People can't believe Japan's chutzpah, as Japan has now essentially committed to being irresponsible, which is very difficult for central banks to do. Coming out now, and promising that inflation would be hard-capped at 2% would reintroduce that perception fo responsibility, and the fears that the old BOJ had come back would materialize.

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Ben Bernanke Testifies Before Congress

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Federal Reserve Chairman Ben Bernanke testified this morning before the Joint Economic Committee of Congress.

The main takeaway from his opening statement was that premature tightening of monetary stimulus risks slowing or ending the recovery.

Bernanke was grilled by Congress over when the Fed will begin tapering off of bond purchases, a prospect markets appear to be taking seriously in the past few weeks as government bonds have sold off and yields have risen. However, Bernanke is just repeating what he has already said in the past – it's dependent on the economic data, and the Fed could decide to decrease or increase bond buying based on how the data unfold.

Nonetheless, markets used this as an opportunity to give up earlier gains.

When asked whether concerns over financial stability stemming from the Fed's involvement in the bond market have increased recently, Bernanke responded that "they have increased a bit."

When asked about the Fed's effect on markets, Bernanke told the Committee that stock and bond prices do not appear inconsistent with the underlying fundamentals, and that asset price issues are "still relatively modest."

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Cash In on Freeport’s Sweetened Plains Deal

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Existing Home Sales Rise 0.6%, Missing Expectations

Existing home sales rose 0.6% to a rate of 4.97 million units in April. This is the highest pace since November 2009.

This was slightly below expectations for a 1.4% month-over-month (MoM) rise to a rate of 4.99 million units.

March's numbers were revised higher to show a 0.2% fall to 4.94 million units.

What's more distressed sales only accounted for 18% of sales, down from 21% in March, and 28% a year ago.

A regional breakdown shows that existing home sales rose the most in the South, up 2.0%. In the Midwest they fell 3.4%, in the Northeast they were up 1.6%, and in the West they were up 1.7%. 

Housing inventory increased 11.9% to 2.16 million which represents a 5.2 month supply at current sales pace, up from 4.7 months supply in March. The national median existing home price climbed 11% on the year to $192,800. This increased for the 14th straight month.

First time buyers accounted for a smaller share of sales at 29% in April, down from 30% the previous month, and 35% a year ago. All cash sales however accounted for a larger part of existing home sales.

"The robust housing market recovery is occurring in spite of tight access to credit and limited inventory.  Without these frictions, existing-home sales easily would be well above the 5-million unit pace," said Lawrence Yun NAR chief economist in a press release. 

"Buyer traffic is 31 percent stronger than a year ago, but sales are running only about 10 percent higher.  It’s become quite clear that the only way to tame price growth to a manageable, healthy pace is higher levels of new home construction."

Existing home sales account for a larger share of the market than new homes, and have outpaced new home sales. And with housing supply staying tight, a rise in existing sales should support home prices.

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MIKE O'ROURKE: We're Now Seeing The 'Iraq' Of Monetary Policy

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This is a new term we haven't seen before.

Mike O'Rourke of JonesTrading says that we're now seeing the "Iraq" of monetary policy, meaning the Fed has entered into an extraordinary situation, from which it has no good plan to self-extricate.

The Iraq of Monetary Policy.    

Is there a plausible exit strategy to avoid endless entanglement?  This is one of the key questions of the Powell Doctrine that leaders are supposed to ask before entering a combat engagement.  Today, NY Fed President and FOMC Vice Chair Bill Dudley gave a speech noting that the Fed’s exit strategy is “stale.”  One might go a step further and say the Fed has painted itself into a corner.  Dudley is a member of the BYD (Bernanke, Yellen, Dudley), the unofficial ruling triumvirate of the FOMC.  Dudley was speaking about monetary policy at the zero bound at the Japan Society.  The key highlight of Dudley's  speech  today for the market was that “Because the outlook is uncertain, I cannot be sure which way—up or down—the next change will be.”  Someone, please let us know when the outlook is certain.

In other "exit" news, POLITICO reported yesterday that Ben Bernanke held a private meeting with some GOP Congressmen, including Darrell Issa, who demanded to learn more about the size of the Fed's bond portfolio.

Bernanke testifies in front of Congress today, so hopefully these topics will come up.

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