Japan Today, Spain Tomorrow

The Bank of Japan did not disappoint and joined the ECB and Federal Reserve in taking new and non-traditional measures. The BOJ did practically everything that we outlined yesterday and justified its move by downgrading its assessment of the economy. 

It increased its asset purchase program by JPY10 trillion to JPY80 trillion. The new purchases will be equally divided between bonds and bills. The BOJ also scrapped the 0.1% minimum bid for rinban operations (regular bond purchases, separate from QE). It extended the program from the middle to the end of next year. The BOJ did seem to hint at a more open ended nature of its QE by indicating that it could be extended if the goal of 1% inflation could be foreseen. 

The dollar rose to four week highs against the yen, just above JPY79.20 (from about JPY78.60 just before the announcement). In Europe, as the euro came under pressure, unwinding of the cross and talk of Japanese-based offers, the dollar slipped back below JPY78.90. It would not be surprising to see the dollar re-challenge the earlier highs in North America today, but general unwinding of risk on trades may limit yen weakness. To summarize, the ECB adopted OMT to save the euro, while the Fed adopted QE3+ to boost employment and the BOJ expanded its ongoing QE in order to arrest deflation.

Tomorrow the euro area flash PMI will be released. The market is not expecting much improved. The Bloomberg consensus is for a composite reading of 46.6 from 46.3. Recently it appears that the survey data has not been as poor as the real data. Over time they can be expected to converge, but it is not clear how it will happen. There is some risk then that the survey data improves more than expected. Nevertheless, it is not the most important event of the day. 

That honor goes to Spain who will attempt to raise up to 4.5 bln euros for its benchmark 10-year bond and 2022 bond. It is the largest bond auction in six months. Current conditions are not particularly conducive. The government is making private placements of bonds for the recapitalization of the regional assistance fund. In addition, after rallying strongly over the past few weeks and especially in light of Draghi's plan, the market has stalled. The 10-year generic yield closed near 6.40 on the eve of the OMT announcement fell to about 5.55% and yesterday flirted with 6%. The 2-year bond was yielding around 3.33% before the ECB meeting and proceeded to fall to 2.71%, but finished yesterday yielding 3.42%. 

A poorly received bond auction might be the trigger for Prime Minister Rajoy to seek formal assistance. Some observers think it could come as early as the end of the week when the economics minister has promised to unveil a new package of reforms to boost growth and confidence. Other observers see a decision by the end of the month. Prime Ministers Rajoy has consistently disappointed investors (and apparently constituents) with the glacially slow decision-making process. The deputy prime minister continued to tease the market yesterday by suggesting aid could be sought depending on the conditions. We think the process may still drag out a bit further, into next month. 

Meanwhile, the financial conditions in Spain continue to worsen, outside of the sovereign realm. Spain reported that bad loans rose to a record 9.82% in July up from 9.4% in June. With home prices continuing to decline, the economy still contracting, and unemployment at incomprehensible levels, the deterioration of loan book seems only able to continue. At the same time, and understandably, lending has been cut and in July was 5% below year ago levels.