“Why All Eyes Are Suddenly Back On The Bank Of Japan”
As a result of the ongoing bond rout, an interesting dynamic has emerged post the recent sell-off. With 10 year Japanese yields edging back above zero intra-day yesterday and again this morning (currently 0.027%) for the first time since September 21st the market is now watching the BOJ’s every move, and specifically whether the Japanese central bank will defend the zero level, as it declared it would at its especially if the global yield sell-off gathers pace over the coming weeks and months.
Asa reminder, on September 21, the BOJ surprised the world when it announced its latest monetary policy iteration dubbed “QQE with Yield Curve Control», according to which the BOJ would buy JGBs such that 10-year yield remain at the current level of around zero percent. Ironically, at the time – when yields were far lower – the BOJ was implicitly threatening it would taper purchases to prevent yields from going too low. It is now, however, facing the opposite problem as suddenly global yields are soaring following the Trump presidency.
Why the keen focus on what Kuroda will do next? Because as DB’s Jim Reid explains, «it would be a strange decision to abandon the new policy so soon after announcing it so assuming global yields remain elevated they may be forced to buy more JGBs than they thought when the new scheme was announced.»
But where the BOJ’s reaction gets more interesting is what it means internationally: if the BoJ sticks to defending zero in a world where the US is likely to increase fiscal spending then you could make an argument that there is full blown helicopter money except that the BoJ is flying the copter over the US and may be about to become the new US government’s best friend.
Alternatively, one can make the argument that Trump is Japan’s best friend, with his election sending the Yen plunging by 8% in only one week.
Reid concludes that without the BOJ and without the ECB, it might be that Trump would be less able to spend freely on the fiscal side as yields would be less supported globally.
Unless, of course, Kuroda flip-flops and announces in the next BOJ meeting that QQEWYCC was a failed experiment at controlling the yield curve, one whose time has passed, and the result will be a spike in long yields across the globe, as the anti-Trump bond vigilantes, who were frozen for years under the Fed’s financial repression, wake up and make up for their long absence by slamming the global bond complex, in the process making any Trump fiscal easing contingent on Yellen launching QE4, as we speculated yesterday may very well end up happening.
“ Financing the Climate-Change Transition”
Unless the world reduces greenhouse-gas emissions rapidly, humanity is likely to enter an era of unprecedented climate risks. Devastating extreme-weather events are already increasing in frequency, but much of the worst climate-related damage, such as a sustained rise in sea levels, will be recognized only once it is too late to act.
Clearly, the climate system’s time horizon does not align well with the world’s much shorter political and economic cycles. Listed companies report on a quarterly basis, and recent regulatory changes, such as those mandating increased use of mark-to-market accounting, limit long-term thinking.
Governments usually have legislative cycles of no more than four years, and they must also respond to immediate developments. Yet stabilizing the climate requires sustained and consistent action over an extended period.
AXA and UBS, together with the Potsdam Institute for Climate Impact Research, CDP (formerly the Carbon Disclosure Project), and the EU’s Climate-KIC (Knowledge and Information Community) recently organized a conference in Berlin. There, they discussed with leading experts in green investments and fossil-fuel divestment how financial intermediaries can help to address climate risks.
The financial industry’s active involvement is urgently needed. In the Paris climate agreement reached last December, countries worldwide agreed to limit global warming to well below 2° Celsius, thereby defining the track on which the world must progress rapidly. Over the next 15 years, an estimated $93 trillion will be needed for investments in low-carbon infrastructure.
Government funding alone cannot meet this demand, so the financial sector must help fill the gap. By redirecting capital flows toward proactive efforts to mitigate and adapt to climate change, financial institutions can protect client assets from global climate risks, and from the economic risks that will attend a warming planet. They are also demonstrating their social responsibility for the wellbeing of future generations.
But financing change requires changing finance. And this process is already underway. Development institutions such as the World Bank are reconsidering their investment policies. And, in the private sector, there is growing enthusiasm for “green” bonds, loans, indices, and infrastructure investments.
Still, as the European Commission notes, less than 1% of institutional assets worldwide are invested in environmentally friendly infrastructure assets. Given historically low interest rates and the general lack of attractive investment options, this is an ideal moment to tap into investors’ growing appetite for green financial products.
Many large financial institutions have recently joined a global initiative promoting fossil-fuel divestment. Research findings indicate that global CO2 emissions must be restricted to less than one trillion metric tons between 2010 and the end of the century to comply with the Paris agreement and limit global warming to below 2°C. This means that most available coal, oil, and gas reserves must stay in the ground.
As a result, investments in fossil-fuel energy sources will continue to lose value over time, eventually becoming stranded. Thus, the financial sector’s revaluation of such holdings not only helps to stabilize the climate, but also better protects its clients’ investments, and, by preventing the creation of a “carbon bubble,” helps to stabilize economies. But selling off these holdings will not suffice; the freed-up assets must also be redirected to more sustainable businesses.
For financial institutions and investors to do their part, they urgently need a better understanding of the relevant climate-related investment risks, which the Financial Stability Board (FSB) has divided into three categories: physical, transitional, and liability. Informed investment decisions will require sound, scientifically grounded data and uniform standards to assess these risks, and to quantify opportunities against them.
Effective disclosure will hence be a key part of any new framework. An FSB taskforce – comprising representatives from banks, insurers, institutional investors, rating agencies, consultants, and auditors – is currently shaping voluntary standards, so that companies provide consistent and comparable climate-related financial disclosures to their stakeholders, whether investors or lenders. This will also allow companies to gain valuable insights into their own potential for change, reflecting a time-honored principle: what gets measured, gets managed.
This is no easy task. For example, carbon footprints on their own will not steer investments in the right direction. Instead of identifying the champions of environmentally friendly solutions, these figures merely reveal which companies currently emit the most greenhouse gases. Meaningful disclosure standards must take account of sector-specific information and the impact on business strategies of the transition toward a low-carbon economy.
All the governments that signed the Paris agreement can now be expected to adopt a range of measures to enable them to implement their de-carbonization strategies. In this context, carbon pricing will be an essential part of the policy toolbox. Some governments have already taken steps to promote the development of green products, via tax or market incentives. Overall, such changes to legal frameworks must support, not impede, the private financial sector’s efforts to tackle climate change.Financing the infrastructure projects that are too expensive for some national governments to finance on their own, but that are essential to the transformation of our energy system – such as wind farms and long-distance power lines – will require a new class of global infrastructure bonds. In the past, governments have encouraged investment in government bonds. Now, in order to increase private investment in building up clean infrastructure, investor-protection measures and dispute-resolution mechanisms must be considered.
The financial sector is ready to spearhead the shift to sustainability. When Germany takes over the G20 presidency next year, it will have the opportunity to convince its partners to create an adequate framework to encourage change in the financial sector that ensures a smooth adjustment to a low-carbon economy. For both public and private actors, the time to act is now.