Morning comment: BoJ after the Fed

Chris Scicluna
Mantas Vanagas

Overview:
Over the past thirteen hours or so markets have been dominated by reaction to the Fed. As widely expected the Fed hiked its funds target range by 25bps – by unanimous vote – and lifted the interest rate on excess reserves by a slightly smaller 20bps. The forecasts accompanying the decision portrayed a slightly weaker outlook for near-term economic growth, a 0.1ppt downward revision to the assumed long-term unemployment rate (now 4.4%) and a 0.1ppt downward revision to core inflation across the entire forecast horizon (the core PCE deflator is now expected to end this year at 1.9%Y/Y, and at 2.0%Y/Y in subsequent years). As a result, the median meeting participant forecast two further 25bp rate hikes in 2019 – one fewer than forecast previously – and the long-term assumed neutral fed funds rate was brought down to 2.8% from 3.0% previously. The fed funds rate is expected to rise slightly above that level to 3.1% in 2020 and 2021 – 30bps below the peak projected previously.

In the accompanying statement and post-meeting press conference the risks around the outlook continue to be described as “roughly balanced”, with the statement adding the observation that the Fed “will continue to monitor global economic and financial developments and assess their implications for the economic outlook.” This addition acknowledged recent weaker global data and ongoing risks to the outlook, as well as what Chair Powell described as “a little bit” of tightening of financial conditions. Powell emphasised that the changes to the Fed’s baseline outlook are relatively small and “have not fundamentally altered the outlook”. However, he emphasised that the actual path of policy will be dependent on future developments.

While the Fed moved its rhetoric in a dovish direction, the extent of the move was clearly much smaller than what equity markets had come to expect (or at least hope for). After being up more than 1% just ahead of the Fed’s announcement, the S&P500 moved lower immediately after the announcement, with the move to the downside accelerating during Chair Powell’s press conference. Investors seemed especially disappointed when Powell appeared to rule out any change in the Fed’s balance sheet reduction strategy, which he characterised as being “on automatic pilot”. At the close the S&P500 was down 1.5%, recovering slightly from losses that had amounted to as much as 2.2% at one point. The US dollar pared earlier losses to be little changed. Meanwhile, Treasury yields moved lower – the 10-year rallying 5bps to 2.76% – and the 2-10s curve flattened to just 11bps.

With that background, not surprisingly Asian equity markets have generally posted solid losses today, with little positive reaction to news that the US Senate had passed a continuing resolution to prevent a government shutdown. This is especially so in Japan, where the TOPIX fell 2.5% after the BoJ announced no change in its policy settings or guidance from that last reaffirmed in late October. The Bank also provided no new signs that its upbeat outlook for the economy had been rattled by recent data or other developments at home and offshore (more on this below). Losses elsewhere in Asia were less severe, with markets in Hong Kong, mainland China and South Korea losing about 1% but markets in Australia and Singapore proving a little more resilient.

Inevitably, therefore, European equities have opened on the back foot this morning, with most euro area government bonds (except BTPs) making gains. Ahead of today’s BoE announcement and UK retail sales data, Gilts are among those to gain most.

Japan:
While the Fed obviously set the tone for markets, the main economic focus in Japan today was on the BoJ’s final monetary policy meeting for this year. As widely expected, the Board made no changes to its key policy settings i.e. the -0.1% interest rate on banks’ marginal excess reserves and pledge to keep 10Y JGB yields ‘at around zero per cent’. To achieve the latter goal it repeated that it would maintain its JGB purchases at an annual pace of “about ¥80trn” – more than twice the recent pace – with purchases continuing to be conducted “in a flexible manner” and with yields permitted to “move upward and downward to some extent mainly depending on developments in economic activity and prices”. The BoJ also retained its caveat that “In case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately.” – a commitment that seems unlikely to be tested in the current risk-off environment. Similarly, the BoJ retained its forward guidance committing to “maintain the current extremely low levels of short- and long-term interest rates for an extended period of time”.

Adding to the overwhelming sense of continuity, Goushi Kataoka again dissented in favour of the Bank pursuing an even more accommodative policy stance with the aim of driving bond yields lower. And Yutaka Harada maintained his dissent, again holding the view that the policy with respect to the allowed movement in JGB yields was too vague to be a guideline for market operations. Finally, the Board unanimously re-committed to increase its ETF holdings at an annual rate of ¥6trn and its J-REIT holdings at an annual pace of ¥90bn, again with the proviso that the Bank may increase or decrease the amount of purchases depending on market conditions.

The Bank’s description of the recent performance of the economy was almost a verbatim repeat of that set out in the last Outlook Report in late October. Notwithstanding the decline in GDP that is now estimated to have occurred in Q3, the BoJ continues to hold the view that “Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating”. Financial conditions continue to be described as “highly accommodative” and the description on both inflation and inflation expectations was also unchanged. Looking ahead, there was similarly no budging of the Bank’s optimism that “Japan's economy is likely to continue its moderate expansion”, with the virtuous cycle expected to continue to operate against the background of highly accommodative financial conditions and increased government spending. Exports are expected to continue their moderate increasing trend on the back of overseas economies growing still “firmly on the whole”.

As a result, the Bank continues to expect that inflation will likely increase gradually toward 2% thanks to a sustained positive output gap and an eventual lift in inflation expectations. But global issues such as Fed policy tightening, protectionist trade measures and Brexit continue to be cited as the key risks to the outlook. And, completing an unchanged outlook, the post-meeting statement concluded by noting that the Bank “will examine the risks considered most relevant to the conduct of monetary policy and make policy adjustments as appropriate, taking account of developments in economic activity and prices as well as financial conditions, with a view to maintaining the momentum toward achieving the price stability target”.

While the outlook as described in the statement was unchanged, in his press conference Kuroda appeared to acknowledge the recent deterioration in conditions and emphasised that “if we think doing so would be necessary to sustain the momentum for achieving our price target, we will ease monetary policy further as appropriate” adding that “Options include cutting the short-term interest rate target, lowering the long-term yield target, ramping up asset buying and accelerating the pace of increase in base money.” We don’t expect to see such action taken, at least for a while yet. But attention will now turn to the next scheduled meeting which concludes on 23 January, at which the Bank will be required to formally update its forecasts for growth and inflation in the accompanying Outlook Report. We fully expect to see downwards revisions made to those forecasts together with an assessment that, due to global factors, the risks are now even further skewed to the downside.

The only economic data released in Japan today was the All Industry Activity Index for October. With METI having already reported a 2.9%M/M rebound in industrial production and a 1.9%M/M rebound in tertiary activity, there was no surprise to see the All-Industry Activity Index post a very strong increase of 1.9%M/M – just 0.1ppt below market expectations – following a decline of 1.0%M/M in September (0.1ppt larger than estimated previously). Annual growth picked up to 2.3%Y/Y, compared with the 1.2%Y/Y decline reported in September.

As usual, the new data in this release concerned the construction sector, where output fell 1.2%M/M and 3.5%Y/Y in October. Private sector activity was unchanged, but public sector building and engineering fell 2.3%M/M and was down 7.5%Y/Y. The overall outcome for October leaves the All Industry Activity Index sitting 1.3% above its Q3 average. So while a pull-back in activity would seem likely in November – as trading patterns return to normal following the disruptions seen in Q3 – today’s report tallies with the signals from recent surveys in suggesting that Japan’s economy is on track to return to modestly positive growth in Q4.

US:
As the dust settles on the Fed’s announcements, the Philadelphia Fed manufacturing survey results for December, Conference Board leading indicator for November, and usual weekly claims figures will be released today in the US.

UK:
With the ECB, Fed and BoJ meetings now out of the way, today it’s the turn of the BoE’s MPC to conclude its final policy meeting of the year. Since the publication of the Bank’s Inflation Report in November, UK economic data have largely been soft, with growth momentum seemingly ebbing away, many business and consumer survey indicators weakening, and inflation surprising on the downside despite further evidence of a tight labour market. And given the ratcheting up of uncertainty surrounding Brexit, tomorrow’s policy meeting seems likely to see the Bank keep its powder dry, with Bank Rate unchanged at 0.75% and the key policy guidance from November repeated. So, the MPC will likely restate that “were the economy to continue to develop broadly in line with the November Inflation Report projections, an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to the 2% target. Any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.” We would not rule out, however, somewhat more dovish language.

The most notable item in today’s UK economic data calendar is the November retail sales report. Having picked up rapidly over the summer months, activity on the High Street slowed significantly in September and October, with both months reporting decreases of around ½%M/M. While we might see a small increase in November, this is unlikely to match the 0.5%M/M gain seen in the same month a year ago, implying that the annual rate of growth should extend the downward trend and fall further from 2.2%Y/Y in October. We will also receive more up-to-date insights into how the retail sector has been performing in December from the CBI Distributive Trades survey. The Agents’ Business Conditions survey from the BoE will be worth watching too.

Euro area:
Today should be another uneventful day for economic data from the euro area with the ECB’s balance of payments data for October arguably most notable.

Australia:
The focus in Australia today remained on the labour market with the release of the Labour Force survey for November. In headline terms employment grew a much stronger-than-expected 37.0k during the month following slightly downwardly-revised growth of 28.6k in October. Base effects meant that annual growth in employment still slowed 0.2ppt to 2.3%Y/Y. 

The detail was somewhat less favourable as full-time employment fell 6.4k – breaking a very strong run of gains over the previous five months – so that annual growth fell back to 2.1%Y/Y from 2.8%Y/Y previously. Part-time employment jumped 43.4k and so was up 2.7%Y/Y. The changed composition of employment meant that the number of hours worked fell 0.2%M/M, lowering annual growth to 1.1%Y/Y. Elsewhere in the report, the labour force participation rate rose 0.2ppt to 65.7, thus falling just short of the high reached back in January. As a result, the unemployment rate edged up 0.1ppt to 5.1% from the 6½-year low seen over the previous two months. All up, given the month-to-month volatility of the Labour Force survey, this was not a report that will have changed the RBA’s optimistic outlook for the labour market. 

New Zealand:
The main focus in New Zealand today was on the national accounts for Q3. The headline production-based measure of real GDP rose 0.3%Q/Q – just half as strong as market expectations and the softest outcome since Q413. Annual growth slowed to 2.6%Y/Y from an upwardly-revised 3.2%Y/Y previously (most of that revision due to a more positive assessment of growth in Q317). The expenditure-based measure of real GDP rose a slightly more robust 0.5%Q/Q and 2.7%Y/Y. Real gross national disposable income – which better represents resident’s purchasing power – rose 0.9%Q/Q and 3.1%Y/Y.

The detail of the expenditure series revealed that private consumption rose a solid 1.0%Q/Q, but public sector consumption fell 1.1%Q/Q. While residential investment rose 1.3%Q/Q, business investment fell 2.1%Q/Q as plant and machinery investment fell 1.6%Q/Q and infrastructure spending fell 4.2%Q/Q (the latter due to the wind-down of repairs following the Kaikoura earthquake). Exports rose 0.3%Q/Q while imports fell 0.2%Q/Q. The production-based series reported a 0.5%Q/Q lift in activity in the services sector, but goods production fell 1.0%Q/Q. Nominal GDP rose 0.9%Q/Q and 3.9%Y/Y. Finally, it is worth noting that the population grew 2.0%Y/Y in the year ended Q3, so per-capita real GDP growth was 1.0%Y/Y over that period.

This outcome was weaker than the 0.7%Q/Q outcome that had been factored by the RBNZ in the November Monetary Policy Statement. This added downward impetus to local interest rates and the Kiwi dollar, which were already under downward pressure in the wake of the market’s reaction to the Fed’s commentary. Both local and global developments add to the likelihood that 2019 could be another year of stable monetary policy in New Zealand, in line with the RBNZ’s baseline forecasts.

In other less surprising news, New Zealand reported a merchandise trade deficit of NZD0.86bn in November – very close to market expectations and down from a deficit of NZD1.32bn last month. As a result, the annual deficit declined to NZD5.42bn after reaching an 11-month high in October. Both exports and imports were close to market expectations. Seasonally-adjusted export values rose 2.8%M/M so that annual growth picked up to 7.1%Y/Y from 5.7%Y/Y previously. On the same basis, import values fell 3.1%M/M and were down 0.6%Y/Y. Weighing on the latter was a 34.3% Y/Y decline in capital transport imports (influenced by volatile monthly aircraft imports) and a 34.7%Y/Y decline in motor vehicle imports. Imports of general consumption goods rose 6.2%Y/Y.

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