Central Banks Roil Markets

The Bank of Japan defied expectations and its economic assessment to  leave policy unchanged.  The inaction spurred a 3% rally in the yen and an even larger slump in stocks.  The financial sector took its the hardest and dropped almost 6%.  The yen's surge helped underpin other Asian currencies, especially the South Korean won, which gained nearly 1%.

At the end of January, the BOJ surprised by adopting negative interest rates for a small part of Japanese banks' excess reserves.  The yen strengthened markedly.  Now the BOJ disappoints in not easing policy.    Prior to the BOJ's announcement, and in response to poor data that showed the most deflation in three years (-0,3% year-over-year on a core measure of CPI that excludes fresh food), a larger than expected slide in overall household consumption (-5.3% year-over-year), the dollar had approached JPY112.00.  The dollar dipped briefly below JPY108 in early European activity.  The greenback sits near its lows ahead of the start of the North American session.

The BOJ did do something.  It cut its inflation and growth forecasts and delayed for the fourth time in around a year when it would achieve its inflation target.  It now stands at some time in the next fiscal year.  We have long argued that it is unhelpful for the BOJ cast its inflation target as a near-term objective.  Other major central banks are talking about their inflation target as a medium-term objective, and this provides more degrees of freedom.

BOJ Governor Kuroda sounded dovish, and the pressure to ease policy in the coming months, perhaps in July, remains possible.  The ostensible argument for standing pat is to monitor the impact of the recent easing.  However, the BOJ's economic forecasts are consistent with the aggressive easing having little positive impact.  Some speculate the Kuroda was sending a message to the Abe government, consistent with the G7/G20 concerns about the over-reliance on monetary policy.  The lack of new monetary action may add pressure on the government for a bolder fiscal policy initiative.

The Nikkei sold off hard.  We had warned yesterday that should the BOJ disappoint, the Nikkei could fall toward 16773.  In fact, it fell to 16652 and closed on its lows.  Depending, of course, on what happens over the next 12 hours, the Nikkei could gap lower tomorrow.  The downside risk extends toward 16000 now.

Most Asian markets fell, and the MSCI Asia-Pacific Index slipped 0.2%, extending its declining streak to the fifth consecutive session.  Recall losses at the start of last week snapped an eight-day advance.   European bourses are lower, and the Dow Jones Stoxx 600 is off 1.25%, led by health care and financials.    The S&P 500 is trading nearly 0.8% lower.

The push higher in global bond yields ended with a bang today.  Core 10-year benchmarks in Europe are off six bp.  Of note so is the 10-year Portuguese bond.  Tomorrow DBRS will review Portugal's credit rating.  It is the only rating agency that the ECB uses that give Portugal an investment grade.  If it takes it away, Portuguese bonds will not qualify for purchases under the ECB's bond-buying program.  It would join Greece and Cyprus.

The US 10-year yield, which had been approaching 2.0% earlier this week, fell yesterday after the FOMC failed to alter investors skepticism about a June hike.  Perhaps in anticipation of easier BOJ policy would spur Japanese demand for US Treasuries also weighed on yields.  Today the yield is close to 1.80%.

The US reports weekly initial jobless claims and the first estimate of Q1 GDP.  Recall that last week, the week of the nonfarm payroll survey, weekly initial jobless claims fell to their lowest level since 1973, and continuing claims fell to their lowest level since 2000.  A small correction would not be surprising.  Yesterday's better than expected advance report of US merchandise trade balance encouraged economists to revised their Q1 GDP forecasts a bit higher.  Nevertheless, a poor number is expected today.  The US economy practically stagnated.  The median expectation is for 0.6%, which is an annualized pace.

The FOMC statement recognized the weaker demand (consumption is expected to have slowed to 1.7% in Q1 from 2.4% in Q4 15) but seemed to emphasize the strength of the labor market and that associated income that can fuel consumption going forward.   Note that the Core PCE deflator in the GDP report is expected to rise from 1.3% to 1.9%, though tomorrow with the month report, the core PCE deflator is expected to ease to 1.5% from 1.7%.

The failure of the FOMC to reestablish a risk assessment in its statement failed to convince investors one iota that a June hike was likely.    Surveys suggest economists are more enthusiastic than investors about the prospects for a hike.  We agree with the Fed’s domestic economic assessment that the economy is likely to recovery in the months ahead from the soft patch it hit over the past six months, and we expect price pressures to be steady to higher.  However, our concern is the global and financial developments, which the Fed dropped as a risk but said it would continue to monitor closely, are likely to be less favorable in two months than they may appear today.   

After the Japanese yen, the New Zealand dollar is the strongest of the majors.  It is up about 1.6%, having been up closer to 2% earlier.  The central bank left policy on hold.  Although this seemed like the odds-on more likely decision, as we argued, the OIS market had a little more than a third of a cut discounted.  There was nothing hawkish in the statement.  There were the usual complaints about the currency's strength, and the central bank was clear that further easing may be "required" to bring inflation toward the middle of its target range.

Today seems to be one of the few occasions that the Australian dollar followed the New Zealand dollar.  Soft inflation reported yesterday weighed on the Aussie, pushing it down two cents to $0.7550.  Dragged higher by the Kiwi, it reached almost $0.7660 before running out of steam.

European news has been overshadowed by the Asian-Pacific developments.  However, it should not be lost on investors that the preliminary CPI readings from Germany and Spain were poor.   Deflationary forces strengthened in Spain.  The harmonized CPI measure slumped to -1.2% year-over-year.  This is the matches the low from February 2015, which is just above the cyclical low from the month before (-1.5% in January 2015).  German states mostly reported softer than expected inflation and this poses downside risk for the national measure due early in the North American morning.

Despite the German Finance Ministry and others complaining about too easy of monetary policy, and ideas that the euro is undervalued for German producers, the world's fourth-largest economy does not appear to have escaped deflation either.  The March CPI was 0.1% above a year ago levels.  Prior to the states' reports today, the median expected a flat reading in April.

Separately, Germany reported a decline in unemployment for the seventh consecutive month, with the unemployment rate steady at 6.2% a record low.    We note that Japan's unemployment rate eased to 3.2% from 3.3%.  In both Germany and Japan, which have full employment, wage growth is minimal.  US wage growth is only slightly better.