Central bank inflation scorecards will be marked this week
- Inflation updates due from US, Eurozone and Japan have already been released
- No improvement over last month is expected in inflation data
- The BoJ is forging ahead but there is no light at end of the tunnel yet
Month end is when the score cards of the major central banks are marked, the score representing progress on meeting inflation targets. The US Federal Reserve, the European Central Bank and the Bank of Japan have set the rules of the game themselves: as far as monetary policy is concerned, all other economic data releases are irrelevant unless they have moved the inflation dial.
But when the numbers are in by mid-week the dial won’t have moved much, if at all. In the US, the price index of core personal consumption expenditures – the Fed’s benchmark – is expected to have increased at an annual rate of 1.5%, no improvement on the previous month. Those expecting new Fed Chairman Jerome Powell to put a positive spin on this in his Congressional testimony on Tuesday and Thursday will be disappointed.
Similarly, the Eurozone equivalent is forecast to also hold steady at 1%. ECB President Mario Draghi is firmly on record as saying this is only barely acceptable.
Even less promising, the Consumer Price Index numbers for Japan were released last Friday and showed the annual headline rate stuck for the third consecutive month at 0.9% while the core rate lingered at just 0.4%.
The Bank of Japan’s official position is that it will continue expanding the monetary base “until the year-on year rate of increase in the observed CPI exceeds 2% and stays above the target in a stable manner”. They expect that to happen “around fiscal 2019”.
The key word here is “observed”. Its inclusion means monetary base expansion (bond buying) will continue until 2% inflation is staring the BOJ right in the face. In contrast, the FOMC is adjusting policy based on its inflation forecasts and the ECB has indicated it will do the same. Those traditionalists are worried about shutting the door after the horse has bolted. The Bank of Japan wants the horse to bolt: they’ll worry about putting it back in its box later.
To that end, the central bank has now accumulated close to half the Japanese government bonds (JGBs) on issue, way ahead of the other QE practitioners as shown in this chart.
Source: Goldman Sachs. Create your own charts with SaxoTrader; click here to learn more.
Yet despite the commitment to charge ahead regardless, the BoJ has actually reduced the rate of bond buying in the last few months. Officially the bank is conducting purchases “at an annual pace of increase in the amount of JGBs of about 80 trillion yen”, but as the following chart shows, purchases have dropped well below that number.
Source: Reserve Bank of Australia
In what some see as stealth tapering, the BOJ has decided to prioritise yield curve control over a their previous “buy at any price” strategy. Under the yield curve control policy, the bank’s deposit rate is being held at –0.10% and the 10-year government bond at “around zero percent”. Their determination to hold the line is shown in the chart shown below (click to enlarge). Every time the yield on the bond approaches 10 basis points, dealers are informed the bank will stand in the market for an unlimited amount close to that rate.
Prior to the introduction of yield curve control the BoJ aggressively pushed the whole yield curve under zero percent, with the 10-year reaching –0.30%, as shown in the chart. That caused alarm in the banking circles. “Financial intermediation” was seen to be at risk of coming to a grinding halt. Bankers put pressure on the BoJ to re-institute a positive yield curve.
Japanese government bonds chart
The policy of holding the line on yield curve control has seen the previously strong relationship between USDJPY and the US versus Japan 10-year bond spread break down, as illustrated in the chart below. JPY is now strengthening even as the yield gap widens.
USDJPY versus real rate differential chart
Source: Pictet Wealth Management
The relationship between FX rates and interest rate differentials has broken down – for the moment. It could be reinstated as quickly as it disappeared but in the meantime traders are floundering around looking for some other fundamental guide to their positioning. Some argue the US dollar is weak because of a perceived twin-deficits problem. Others that the US rate hiking cycle is mature while there is much more upside in the Eurozone and Japan, however far on the horizon that may be.
In the short term expectations are high that Jerome Powell will clear the air in his testimony to Congress this week. Don’t bet on it: the Fed’s semi-annual report to Congress is fresh off the press and contained few insights or guidance. The new man in charge is likely to stick very close to it.
– Edited by Robert Ryan
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Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.