US Federal Reserve taper likely to be offset by Bank of Japan's liquidity splurge

Jul 22 2014, 14:57 IST
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One might think that the Zero Interest Rate Policy (ZIRP) era is coming to an end One might think that the Zero Interest Rate Policy (ZIRP) era is coming to an end

One might think that the Zero Interest Rate Policy (ZIRP) era is coming to an end. The US Federal Reserve will be concluding its Quantitative Easing (QE) program by year-end and we can expect the first interest rate hike in mid-2015. The Bank of England (BoE) is sounding hawkish as is seen by the run-up in the pound over the past few months. The Reserve Bank of New Zealand (RBNZ) has already started hiking interest rates and is widely expected to raise the benchmark rate further by 25 basis points.

One might think that the Zero Interest Rate Policy (ZIRP) era is coming to an end. The US Federal Reserve will be concluding its Quantitative Easing (QE) program by year-end and we can expect the first interest rate hike in mid-2015. The Bank of England (BoE) is sounding hawkish as is seen by the run-up in the pound over the past few months. The Reserve Bank of New Zealand (RBNZ) has already started hiking interest rates and is widely expected to raise the benchmark rate further by 25 basis points later this week. The European Central Bank (ECB) has said that it would unleash a European version of QE if deflationary threats are not overcome but there remain too many legal and political challenges for Mario Draghi to implement the QE. One has to look far east to the Bank of Japan to answer the following question: Where will the liquidity come from post the ZIRP era?

In April 2013, the Bank of Japan (BoJ) launched an aggressive unconventional monetary easing program with the aim of doubling its monetary base in two years. The BoJ has since been injecting $60-80 billion per month into the financial system via purchases of government bonds and risk assets. Real yields on 10-year Japanese Government Bonds (JGBs) have been in the negative territory since last August. It is worthwhile to remember that with respect to the monetary base of the economy, Japan's QE has been the largest-scale monetary stimulus in the history of finance (larger than the US Federal Reserve's).

It is important to understand various capital flows as a result of Japan's QE which might provide as a buffer as the US Fed unwinds its QE program. This is one of the reasons, along with earnings upgrades, why market participants will remain bullish in the second half of the current financial year. Firstly, let us take

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