Fed and BoJ Watch
The Federal Reserve is likely to opt for more inaction and the Bank of Japan could double down on negative rates.
The Federal Reserve is likely to opt for more inaction and the Bank of Japan could double down on negative rates.
Investors’ best guess of what the BoJ and Fed will decide follows a fraught few weeks in global markets that link directly to monetary policymakers’ aggressive efforts to stimulate economic growth. Results have been mixed-to-disappointing, and some of the fall-out has even left central banks at odds with their own ‘price stability’ remits.
The latest example was a sudden revival of benchmark bond yields across the German and Japanese curves which lifted Japan’s 30-year paper from almost zero in July to 0.55% last Friday. Rising yields in the past signified expected lower demand for government borrowing and in turn, improving economies.
But the speed and volatility of the yield jump, accompanied by the VIX volatility index’s biggest rise since June on 9th September, tells us the gyrations don’t signal increased risk appetite.
Fear and confusion are likelier explanations.
As much as investors fear the end is nigh for the Fed’s ‘lower-for-longer’ regime, anxiety has also emerged on the Bank of Japan’s (and the European Central Bank’s) flood of cheap money.
The chief worry is that huge asset purchase programmes will run out of assets to purchase before they reach their goal of rekindling inflation.
There’s more urgency in Tokyo.
Having hoovered up 80 trillion yen ($775bn) a year of government bonds for less than two years, the BoJ already owns around 40% of Japan’s official debt. Squabbles about how effective the outlay was—core inflation recently slipped back below zero—have split BoJ rate setters.
Japanese lenders’ reluctance to dispose of bonds used as collateral also stokes a worry that the BoJ could soon face a bond shortage.
Spats reached a tipping point this year following the addition of negative rates to the BoJ’s ‘Quantitative and Qualitative Easing’. Two dissenting rate setters resigned shortly after. These exits and the safe-haven yen’s 16% ascent this year contributed to BoJ Governor Haruhiko Kuroda’s decision to announce a “comprehensive assessment” of policy over the summer.
Cue more stock market angst that left the Nikkei 225 down 14% since January.
As the dust settled in recent weeks, the likelihood that the Bank of Japan would throw in the QQE towel to any great degree has diminished.
By and large, Janet Yellen’s Fed is under less pressure to act than the BoJ.
But US rate-setters’ face a similar threat to their credibility as their Tokyo counterparts. Wednesday’s policy update is expected to be accompanied by the fourth cut in 15 months of the Fed’s long-run ‘neutral rate’. The bank’s forecasts have been eroded by stubbornly weak core inflation—as weak as 1.6% year-to-year in August using the bank’s preferred Personal Consumption Expenditures (PCE) price index, well below the bank’s long-standing 2% target.
The PCE result was backed by miniscule overall Consumer Price Index (CPI) growth released last Friday. The core annual CPI outcome was unchanged at just above the Fed’s target, providing the main source of debate among Federal Open Market Committee’s rate (FOMC) setters. But a raft of recent weaker-than-expected data from other parts of the economy kept Federal funds futures contained.
Implied probability of a hike at the time of writing was just 18% compared to 12% a day earlier, according to CME Group data. Probability of a rise at November’s Fed meeting was 23%, and in December 48% vs. 45%.
Bond traders are also sceptical. The yield spread between 10-year Treasury Inflation Protected Securities (TIPS) and benchmark 10-year Treasurys widened almost two basis points to 1.5% after Friday’s CPI release. But that still left this implied bond market forecast of inflation below the Fed’s target, after it fell below 2% two years ago.
Blasé expectations and a pause in growth have crushed the Fed’s earlier hope to hike four times this year. And then there were just two hikes projected. Now, with less than three months of 2016 left, only one seems plausible.
The Bank of Japan decision is scheduled only tentatively and expected early-am London time. The Federal Reserve’s decision will be announced at 7pm BST.