Article / 24 March 2016 at 2:56 GMT

Watch for key inflation updates from Japan, US this Easter

Managing Director / Technical Research Limited
New Zealand
  • The Japan inflation figure will tell us if the BoJ will go deeper into the red on rates
  • Japan’s government bond yield curve continues to flatten out
  • The Fed’s interest rate flight path is an aspiration, not a forecast
  • US inflation data will reveal if the Fed's flight path is credible
  • The odds of an April Fed cut are low, despite bullish talk from Fed's James Bullard
  • There is plenty of scope for USDJPY volatility

By Max McKegg

Financial markets will be closed for four days in many places over the Easter break, but it will be business as usual for economic data releases. The main event will be inflation updates from Japan (on Good Friday) and the US (Easter Monday).

The first number will tell us whether the Bank of Japan is likely to lower its policy rate further into negative territory; the second if the Federal Reserve’s current flight path for the federal funds rate is credible. There is plenty of scope then for volatility in USDJPY.

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Smart traders will keep a close eye on inflation updates from the US and Japan over Easter, so they won't be caught on the hop by FX swings or central bank policy moves. Photo: iStock
 
The following chart sets the scene for release of Japan’s consumer price index. Last month the headline rate (all items less fresh food) came in at an annual rate of zero. This time around a temporary improvement to 0.3% is expected. Similarly, the measure the BoJ has been trying to “educate” markets to concentrate on – CPI less fresh food and energy – should move back up to 0.9% year on year. However, most analysts expect the headline rate (the BoJ’s self-imposed benchmark) to drop back down to zero during the summer months.

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Source: Bank of Japan
 
Last week Bank of Japan Governor Haruhiko Kuroda put a positive spin on the situation when appearing before a parliamentary committee. “Assuming that crude oil prices will rise moderately from the recent level,” he said, “ the timing of the year-on-year rate of change in the CPI reaching around 2% is projected to be around the first half of fiscal 2017”. Traders noted dual use of the word “around”, seemingly to give the governor a bit of wiggle room; room he will need because he is aware as anyone that “the first half of fiscal 2017” is little more than 12 months away.

Kuroda will also be aware that the recent decline in USDJPY is largely offsetting the fall in crude oil. So, given that Kuroda’s mantra over the last couple of years that the BoJ will pursue the 2% target “with the utmost determination”, it’s a good bet that determination will include another cut to the bank’s policy rate, from the current level of –0.1% closer to –0.5%, or perhaps even stealth intervention in the FX markets, Swiss National Bank style.

In fact, intervention is the most likely outcome as interest rate differentials are not having much of an impact on the major FX crosses this year. The Bank of Japan has flattened the yield curve right out, so that 40 year government bonds yield barely 0.50%. Yet still the yen is on the rise. A further complication is that banks don’t want to sell bonds earning a positive return to the BoJ in exchange for a reserve deposit earning negative 0.1%, meaning there is a good chance the central bank will start to fall short of its monthly purchases target of ¥80 trillion. The end of the line for QE.

Japanese government bonds yields for the past 40 years
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Like his central bank counterparts throughout the G10, Kuroda has been hoping the Fed will come to the rescue with an unequivocal commitment to a series of federal funds rate rises over the next couple of years. Unfortunately for all concerned, the Fed is holding back, its “dot plot” representing an aspiration rather than a forecast. What’s needed is more positive economic data; specifically on the inflation front.

So what are the chances we will get it on Monday when the price index of personal consumption expenditures (PCE) is released? 

This chart shows the current state of play with the PCE, the Federal Open Market Committee’s inflation benchmark.

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Source: Advisorperspectives.com. Create your own charts with SaxoTrader; click here to learn more. 

Last week’s policy review statement from the FOMC removed the previous reference to the committee being “reasonably confident that inflation will rise, over them medium term, to its 2% objective”. Why was that? On the face of it, things are moving in the right direction; headline inflation (the red line) has moved up sharply, and core inflation at 1.7% (rounded) is not that far from the magical 2% number. 

In fact, if it wasn’t for the drag caused by the rally in the US dollar last year, core PCE would be exceeding target now. However, base effects (relatively strong numbers in the February-June 2015 period dropping out of the annual calculation) could see core PCE numbers stabilising or trailing off in the summer, in similar fashion to Japan.

This probably explains the Fed’s caution but, ironically, the market has taken it as sign Janet Yellen and her colleagues are prepared to risk the inflation genie getting out of the bottle: the break-even rate on 10 year Treasury Inflation Protected Securities has risen to its highest level since last August.

We’ve heard some positive talk from FOMC members this week, but most of them are non-voters. James Bullard was the exception. He said in a Bloomberg interview there is a risk the Fed may overshoot on inflation and the unemployment rate. FX markets seemed to take that as an indication the Committee’s April 27 meeting might be “live” for a rate hike and US dollar had a nice rally. Not so impressed were money market traders; the odds of a hike remain priced at 10% only. 

Hopefully the Easter inflation updates in both Japan and the US will clear the waters.

– Edited by Robert Ryan

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Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts an article or trade, then click here to follow him.

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