Jefferies Strategist: The ECB and the BoJ Need to Go Way Bigger for Their Easing to Work

Just pushing rates into negative territory isn't enough.

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The Bank of Japan and European Central Bank are pumping roughly $70 billion into the financial system each month, yet global markets are sputtering, inflation is low, and economic momentum remains underwhelming.

That's because European and Japanese quantitative easing just doesn't pack the same punch as the Fed's bond purchasing program, according to Jefferies Chief Market Strategist David Zervos.

For the BoJ and ECB to achieve their objectives, they'll need to push down much harder on the financial accelerator, he said.

"I now believe both the Europeans and the Japanese have massively miscalibrated both the size of QE purchases and the target level of short-term interest rates," asserts Zervos. "In their current form, monetary policy in both regions will NOT generate a reflationary outcome."

The transmission channel of QE by the Fed was much larger than people may have appreciated by virtue of the dollar's role as the reserve currency and other nations' self-imposed financial linkages to the greenback, and more generally, the U.S. monetary policy stance.

The Fed's asset purchases helped make U.S. household deleveraging less painful but also enabled economies that kept currencies at least loosely pegged to the greenback to lever up more easily. China, most notably, may not have had an obvious need for lower real rates or a massive and rapid expansion in credit, but Beijing did so nonetheless. That's because China imported this accommodative U.S. monetary policy, and the way in which the world's second-largest economy reacted to this amplified the effects of the Federal Reserve's asset purchases on real activity globally.

"We took a perfectly healthy Chinese economy in 2009 and shot it full of steroids, thereby creating what will no doubt go down in history as one of the largest monetary policy induced bubbles in history," wrote Zervos.

So when the Fed eased policy in response to the financial meltdown, it eased policy for large swaths of the world in a manner that ECB and BoJ cannot. That makes comparing the asset purchasing programs deployed by these central banks somewhat of an apples-to-oranges exercise.

"U.S. QE, unlike that of European or Japanese QE, comes with an added 'accelerant'—a turbo charged boost via the pegs and the leverage," he wrote. "Comparing U.S. monetary policy to that of Europe or Japan is like comparing the U.S. made Hennessey Venom to a German made SmartCar or a Japanese made P45." 

(As an aside, Zervos quips that perhaps this American accelerant works in reverse—that tightening by the Fed is approximately four times more potent because of these ripple effects. Something to think/worry about.)

The upshot: If it took the U.S. this long to start normalizing monetary policy after rounds of considerably more potent quantitative easing, European and Japanese central bankers have to expend more monetary ammunition to move the dial on inflation.

"For now, I just want to make the claim that the Smart Car and P45 style monetary policies of the ECB and the BoJ are insufficient to create reflation," wrote Zervos. "Looking ahead, I am not sure how quickly Mario [Draghi] and Haruhiko [Kuroda] will come to the conclusion that purchases need to be in the multiple hundreds of billions per month, and nominal short rates need to be LESS than MINUS 1 percent."

The strategist concludes that he's happy staying in his "long spoos and blues" trade (U.S. equity futures and eurodollars) until these two central banks come around to his way of thinking and greatly enhance the degree of monetary accommodation they're providing.

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