- Surprise decision against lowering short-term interest rates
- BoJ seems determined to maintain its easing bias
- The BoJ can now buy – or not buy – JGBs as it sees fit
- A shock Fed rate hike tonight would send USDJPY soaring
- Fed's QE & ZIRP policies drive inequality (but they won't admit it)
The Federal Reserve. Author of its own misfortune. Photo: iStock
By John J Hardy
The Bank of Japan meeting brought very few surprises relative to quite divided market expectations for the immediate policy adjustments. The focus on the yield curve management out to ten years, with a desire to keep nominal yields near current levels around zero at 10 years, was no major surprise. It was a marginally “hawkish” surprise that the BoJ decided not to lower short-term interest rates further in its efforts to steepen the yield curve, though this will likely be forthcoming at future meetings. Meanwhile, the attempt at stronger forward guidance, with the new policy intention to take the CPI in excess of 2%, rather than merely to 2%, is an attempt at seeming more committed to keep the necessary easing in place and not moving in any way from an easing bias.
The most interesting takeaway is that the Bank of Japan has abandoned its set expansion of the monetary base under this new framework, which means that it can slow bond purchases if JGB yields are seen as already low enough, but it also means there is no limit to the amount the BoJ can expand purchases if it sees fit.
From here, the JPY could head somewhat stronger still if the Federal Open Market Committee tonight is dovish, while a shock Fed rate hike could send USDJPY soaring quickly on the theme of policy divergence, unless the Fed were to provide very dovish guidance despite the hike. But longer term, any JPY upside may be relatively constrained as this new BoJ policy framework allows for any level of bond purchases necessary to cover government fiscal expansion – which is on the way with unknown scale and timing, but certainly in 2017. In the grander scheme of things, this is about passing the policy baton on from the BoJ to the fiscal authority as monetary policy is unable to move the economic needle this far into a zero- and now negative interest rate and QE regime.
Chart: USDJPY – 15 minute
USDJPY chart in the immediate reaction to the BoJ meeting, with the initial reaction perhaps driven by the intent to up the forward guidance on the CPI to in excess of 2% and the lifting of any limit to BoJ purchases. Then the JPY was back stronger, perhaps as the market realises that for the BoJ to realise its targets, it will require action from the fiscal authority, with little conviction in the timing or the scale of new stimulus.
Now we’re on to the FOMC this evening, where the strong market consensus is that there will be no rate hike, but with sufficiently loud voices suggesting that we could see a surprise move because the Fed’s credibility has been backed into a corner – so we have a two-way reaction function.
If there is no hike, expect a dissenting couple of voices and a vain attempt to pretend that every meeting is live. If the Fed does shock with a rate hike, expect it to be a relatively dovish hike – not necessarily for whether December remains in play, but watch for a severe downward Fed funds rate forecast in the dot plot. If no hike, we could see the risk/USD crosses moving the most, while a shock hike could set the USD higher across the board, one would think especially against the carry trade currencies (EM and commodity dollars) more than other G3 currencies, though EURUSD looks technical quite wobbly if we punch down through the 1.1125 area after the meeting today.
We would like for Fed chair Janet Yellen, supposedly a labour economist concerned with inequality, to admit today that the Fed has been the chief driver of inequality by pumping asset markets while the real economy languishes, and that the Fed needs to hike rates to counter the risks to financial stability, not because of anything to do with the real economy. ZIRP and QE are driving inequality and the very real possibility of a Donald Trump presidency. But don’t expect the academics at the Fed to admit that they get this just yet.
– Edited by Clare MacCarthy
John J Hardy is head of FX strategy at Saxo Bank