Charles Schwab Has 7 Trillion Reasons To Study Japan
Investors wondering why Charles Schwab Corp. is in the news for all the wrong reasons may find clues in Japan.
As the Federal Reserve’s most aggressive tightening cycle since the mid-1990s puts the financial world off balance, it’s easy to see why Schwab and its more than $7 trillion of assets across all businesses feel under threat.
But the real clues may come from Japan, which is suffering from a similar amount of aversion to financial change.
The ways in which the Fed’s rate hikes slammed Silicon Valley Bank and Signature Bank in the U.S. have Asia on edge. The idea that Schwab, whose assets top Japan’s annual gross domestic product, might hit a wall adds to paranoia that the global capitalist system is stumbling, and fast.
Schwab, like SVB, loaded up on longer-dated bonds at bargain-basement yields in 2020 and 2021. As the Fed accelerated its rate hikes since last year, Schwab found itself with mounting paper losses in a short period. Bloomberg reports that by March 2022, Schwab had more than $5 billion of such paper losses. By year end 2022, that figure jumped to more than $13 billion.
Here, the lessons-from-Japan angle looms large. In the next two weeks, Kazuo Ueda will take the helm at the Bank of Japan. At that point, he’ll face the impossible task of normalizing monetary policy without tanking the economy.
Fears the BOJ is about to pivot away from 20-plus years of quantitative easing is stress-testing Asia’s second-biggest economy. Since the BOJ pioneered QE between 2000 and 2001, free-flowing yen liquidity became part of Japan’s financial DNA.
Any thought that the BOJ might “taper,” never mind a pivot toward an actual rate hike, tends to shake the political and corporate establishments. Look no further than December 20, when outgoing BOJ leader Haruhiko Kuroda tested the globe’s tolerance for the BOJ becoming slightly less stimulative.
It didn’t go well. Kuroda’s move to let 10-year yields rise as high as 0.5% panicked world markets. The yen skyrocketed and U.S. Treasury yields surged as the so-called yen-carry trade went awry.
Since the BOJ pioneered QE, Japan has become the biggest creditor nation. Borrowing cheaply in yen and flipping those funds into higher-yielding markets from India to Poland to Brazil has been a top funding strategy for investors everywhere.
It follows that anytime the yen gyrates, the floor drops out from under global markets. That happened again on December 20, prompting Kuroda’s team to backtrack. The BOJ spent the next few weeks buying additional bonds to signal that its policy hadn’t changed.
This explains the financial minefield into which Ueda steps on April 8, when he assumes the governorship. It may explain, too, why Ueda, in appearances before parliament, went out of his way to signal that the status quo, QE, will remain.
That could change, of course. But Ueda hardly seems ready to test markets again. And the turmoil since then at SVB, Credit Suisse and now questions about Schwab will likely extend the BOJ’s current QE era.
The reason why is that Japan developed a strong addiction to free BOJ money. Any attempt policymakers have made in, say, 2006 or December 2022 to wind down its QE program shook markets everywhere.
Schwab’s plight suggests the U.S. is in the throes of its own tail-wagging-the-financial-dog dynamic. Its scale vastly raises the stakes for the U.S. financial system. Fewer than 20% of Schwab’s depositors 34 million accounts exceed the Federal Deposit Insurance Corporation’s $250,000 insurance cap. At SVB, it was roughly 90%.
Either way, Schwab’s travails suggest the U.S. suffers from more of a Japan-like addiction to low rates than investors may realize.
Your move, Jerome Powell. So far, it appears the Fed chairman is willing to continue ratcheting rates higher. With inflation rising at a 6% pace, Powell’s team reckons it’s not done with the Fed’s most aggressive tightening cycle since the mid-1990s.
It remains to be seen whether America’s financial system can withstand additional Fed moves. In the years since the Fed followed Japan down the QE rabbit hole, bankers seemed to forget that yields can surge. They also seemed to forget how to hedge for markets moving against them.
The risks of collateral damage are growing by the day. That may force Powell’s team to halt the rate cycle—or even reverse course.
It’s worth noting, too, that the Fed is no longer the best team to attack inflation, much of which is coming from high oil prices and supply-side disruptions. A better way to combat overheating is bigger investments in productivity-enhancing technologies.
In the interim, though, Powell’s team seems determined to drive rates higher, regardless of the damage. Yet, as Japan has shown the world time and time again, financial institutions addicted to low yields are poorly positioned to withstand the fallout.
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