Outcome of the Fed and the BoJ meetings
As we expected, the Fed did not raise its rate yesterday. In Asia, the Bank of Japan also decided to leave rates unchanged.
The Fed Meeting
The Fed decided to leave its main rate unchanged, with the federal funds target rate at 0.25-0.50%, as the medium term outlook has not changed substantially. Uncertainties have even increased. As a matter of fact, the weak May job report came as a negative surprise and the UK referendum adds some stress to the market globally.
The Fed updated its “dot-plot” chart. Most Fed members see the gradual path of the rates slower than they previously anticipated. The median path of expected rates was pushed down: 2017 is down 25bps, 2018 is down 38bps, and long-run estimates are down 25bps to 3.0%. Six Fed members see only one hike before year end, compared with one in March. However, the majority of the Fed members still anticipate two hikes of 25bps this year.
The only major change in the Fed’s economic projections was an upward revision in the median 2016, 2017 and 2018 headline inflation forecast, to reflect the higher oil prices. The growth forecast was revised down slightly. Unemployment rate projections were broadly not altered. This is probably due to the weaker payroll gains in recent months, which were accompanied by a drop in labor force participation.
The next steps
The Fed sees its current policy regime as accommodative, not neutral. Increases in prices of risky assets and the weaker dollar since its last forecast have further eased financial conditions. Up until the weak May payrolls, the Fed probably saw reduced global risks and improved domestic data as generating a key opportunity to continue to normalize rates.
The May job report quickly removed the possibility of a near-term rate increase. Key political uncertainties (Brexit and U.S. presidential elections) will push the Fed to remain patient despite our expectations of a gradual improvement in the economic environment over the coming months.
We expect the Fed to hike rates in December and to continue over the course of 2017.
The BoJ meeting
The Bank of Japan decided to leave rates unchanged – more to come
Further yen appreciation pushed share prices and inflation expectations lower over recent weeks. This has put the pressure on the Bank of Japan (BoJ) to ease monetary policy further. The central bank decided today to leave the interest rate on excess reserves (IOER) unchanged. The central bank based its decision on a rather positive economic outlook. Global political uncertainty (Brexit) and the upper house elections in July probably also played a role. The outlook for BoJ policy for July onwards depends greatly on market conditions, but we maintain our view that the BoJ will be forced to ease in the not-too-distant future (base case July).
Further moves will be more likely concentrated on deepening the negative interest rate. This view has not changed. We think that the BoJ adopted negative interest rate policy because the quantitative easing (QE) was nearing its limits. Governor Kuroda stressed that his easing regime now spans the “three dimensions” of quantity, quality, and interest rates. In practice, however, more easing via the first two dimensions has become quite challenging. A further option would be to increase the scale of ETF (exchange traded funds) buying. The volume of risk assets in BoJ’s balance sheet is already very high.
Initial market reactions
- The yen surged, especially against the dollar. The dollar fell against most currencies. Against the euro, the fall was quite moderate (1.12).
- Stocks markets went slightly down in the US after the Fed decision. The move on the Japanese market was as stronger as the Nikkei went down 3%.
- Gold outperformed and broke 1300.
- Bond yields fell moderately across the world. The 10-year Bund is negative (-0.02%).