Forecasting the forecasters
- Markets coiled ahead of key US, Japanese central bank meetings
- Complacent market could still be surprised by a hawkish Fed
- BoJ could push yet further into negative rates
By Neil Staines
“The golden rule is that there are no golden rules” — George Bernard Shaw
Trading sessions so far this week have been more akin to the warm-up sessions where athletes stretch their legs and contemplate strategies before actually competing. With an extremely light data calendar so far, this is perhaps excusable and with imminent and dominant central bank policy meetings in Japan and the US tomorrow, it is certainly understandable.
In Japan, we await not just a monetary policy decision but the release of a report on the efficacy of the Bank of Japan’s policy to date (sadly stopping short of questioning the concept of inflation targeting in favour of questioning the success and efficacy of its current and potential future policy mix in attaining it).
In the US, the central focus appears very binary: will the Federal Reserve raise rates or not? In reality, however, it is never quite as simple as that.
“There are two classes of forecasters: those who don’t know, and those who don’t know they don’t know” — J.K. Galbraith
A few weeks ago, New York Fed president William Dudley stated that the market was “too complacent”, hinting that monetary tightening was closer than then-current market expectations.
Since then, US retail data have implied that consumer spending is likely to slow (perhaps significantly) in Q3, private fixed business investment continues to decline, and recent manufacturing and service sector survey declines suggest a less-than robust-level of current corporate activity despite continued labour market strength.
This ebb of US economic momentum has led markets to price in a less than 20% chance of a rate rise tomorrow. Note that since 1999, the Fed has not increased rates when market pricing has been less than 80%.
Furthermore, the FOMC will also be providing updates of its US economic projections and interest rate forecasts textending into 2019. Within these, it is likely that the average of the long term "dots" will fall below a rate of 3.0%.
Like Dudley, however, we would argue that markets are indeed likely too complacent with respect to the Fed (though the removal or lowering of the concentration of the "dots" implying a rate rise in 2016 would counter this argument). The recent rise in front-end US Libor rates ahead of money market reforms set to come into place on October 14 already represents an implicit tightening.
While we agree with the broad consensus that there will be no change in rates at tomorrow’s meeting, it is likely that the FOMC will want to keep December open as a possibility for the next step of monetary normalisation.
Facilitating that would likely require a statement that is at the hawkish end of expectations.
It is also possible that the Fed will outline a plan to halt the reinvestment of portfolio income (either immediately, or at some point in the future). Any suggestion of this, in turn, would likely give real and nominal US yields a slight upward bias and that in turn should translate into a slight upward bias for the USD.
“The longer the excuse, the less likely its the truth” — Robert Half
Complacency is also apparent in Japan. Market expectations have converged on "unchanged", at least as far as the immediate policy response is concerned. We, however, maintain the view that there is risk of a further push into negative territory for interest rates. There is little upside in BoJ governor Haruhiko Kuroda taking his foot off the gas at this stage and as the "review" of the efficacy of the BoJ’s monetary response stops short of questioning the target itself, we see little chance of a change of tack
(We could see a potential situation in which the BoJ increasingly turns its attention towards further negative rates as a policy stimulus rather than further QQE...)
From an FX perspective we would expect the combination of actions and inactions to result in a higher USD and a weaker JPY, as well as a slightly steeper yield curve in Japan and a slightly flatter yield curve in the US. However, there is sufficient global uncertainty and sufficient addenda to both policy announcements (Fed dot plot and BoJ review) to provide heightened volatility around the announcements.
This leaves the door open for surprise. A reminder of Dudley’s warning may well be pertinent not just with regard to the Fed, but also the BoJ.
— Edited by Michael McKenna
Neil Staines is head of trading at ECU Group