Five and Counting

At the end of last week’s blog post, we mentioned that the central banks of Japan, New Zealand, and the USA would deliver policy announcements. We went on to say that no moves were expected by all three banks but if there was to be a move it would come from the Reserve Bank of New Zealand. On this count, we were half correct. There was a surprise move but it came from Japan not New Zealand, more on that later.

The big surprise of the week was the Bank of Japan adopting negative interest rates. The BOJ will charge 0.1% on any cash left on deposit with the bank. The yen responded with a loss of almost 2% on the week. This move shocked the markets because only a week ago Bank of Japan Governor, Haruhiko Kuroda, told an audience at the Davos World Economic Forum that he would not adopt negative interest rates. The bank’s policymakers, who voted 5-4 to approve the measure, took great pains to say the rate cut was based on global conditions and not the Japanese economy itself. It makes you wonder what the BOJ has seen that has changed their minds so quickly. It also makes you wonder why the Fed’s policymakers are not seeing the same thing.

The BOJ’s latest move makes it five and counting – i.e. five central banks that currently have a negative interest rate policy. The others are the ECB (-0.3%), Denmark (-0.65%), Switzerland (-0.75) and Sweden (-1.1%). We are emphasizing “and counting” because we believe that eventually other western central banks, including the US Fed, will have no choice but to adopt negative interest rates.

There were some changes in last Wednesday’s FOMC statement. The FOMC removed the line about the economy “expanding at a moderate pace” and replaced it with “growth slowed late last year”. They warned that market based measures of inflation compensation “declined further” and that inflation is expected to “remain low in the near term, in part because of further declines in energy prices.” The FOMC also explicitly said they were closely monitoring global economic and financial developments. These were nice dovish additions but we thought that the dropping of “risks being balanced” and the reference to being “reasonably confident” about inflation returning to 2% was more telling.

The changes to the FOMC statement reinforced what the market had already discounted – that the Fed's four rate hikes, as laid out in December’s dot-plot, are a fantasy. Before all the market turmoil in January, the fed funds futures were pricing in just two rate increases by year-end. The market is currently pricing in a single hike this year and traders see a 16% chance that the Fed will raise rates at its March meeting, down from 51 percent at the start of this year.

Looking ahead, it will be another busy week in the currency markets. The first trading week in February will see the release of Chinese PMI, UK PMI, RBA Rate Decision, German Labor Report, NZ Labor Report, BoE Rate Decision & Quarterly Report, US Non-Farm Payrolls, and the Canadian Employment Report.