Kuroda signals yield shift after Fed pivot

Chris Scicluna

A clear dovish shift from the Fed yesterday – with new forward guidance to make clear it is now “ready to act”, and a revised dot-plot showing that eight FOMC members expect to ease policy this year (and one member voted for an immediate cut) – broadly validated the recent downtrend in global bond yields. Admittedly, the markets are still pricing rather more easing than the policymakers signalled, with Fed Funds Futures suggesting a probability of 70%+ of three hikes by year end. So, while US equities made only modest further gains after Jay Powell’s announcement (the S&P500 closed up just 0.3% having been flat for most of the day), USTs rallied. Having extended gains today in Asian time, 2Y yields are now down almost 20bps from yesterday’s high to near 1.71% while 10Y yields are down below 2% for the first time since November 2016.

The Fed’s announcement inevitably gave support to stocks in Asia today, particularly in China where the CSI300 closed up 3.0%. Elsewhere, however, the gains were more modest. Indeed, with the Fed’s announcement having pushed the Yen to ¥107.6/$, its strongest level since January, the Topix closed up just 0.3% as the BoJ predictably left unchanged both its monetary policy and its overall assessment of the economy, repeating against its recognition of the “significant” downside risks posed by events overseas.

In due course, however, Fed rate cuts will see many central banks, probably including the BoJ, also adjust monetary policy. So, the JGB market today pushed yields lower across the curve, with 2Y yields down another 1½bps or so to -0.236%, marking a new more than two-year low, while 10Y yields fell a further 2bps to -0.17%, the lowest since the Yield Curve Control framework was introduced in 2016. Of course, 10Y yields are thus now approaching the bottom of Kuroda’s target range of +/-0.20%. And in his press conference the BoJ Governor restated that rate cuts and more asset purchases were among the various easing options available, and that “flexible thinking” was appropriate when considering the 10Y yield target range, with a predictable impact on the futures market.

Moving to Europe, equities have started the day on the front foot, while government bonds have rallied (10Y Bund yields down about 2bps to -0.31%, with 10Y BTPs outperforming to push the 10Y yield below 2.05%). The dovish tone of the Fed, however, has pushed the euro up about 1 cent to close to $1.13. And not least due to the possible forex market consequences if the Governing Council was to remain intransigent, the greater clarity on the likely future path of the fed funds rate was also enough for us to confirm a shift in our ECB view, with a 10bps cut in the deposit rate to -0.5% (accompanied with a move to tiering) in September now our baseline expectation. That forecast was supported by comments this morning from Governing Council member Olli Rehn – who is a leading candidate to replace Mario Draghi – underscoring that an improvement in economic conditions would now be required to prevent the ECB easing.

Today’s announcements from the BoE, however, seem likely to bring no change in the MPC’s guidance that “gradual and limited” rate hikes are likely to be in store in the UK if and when Brexit uncertainty lifts. We, however, expect no change to BoE policy over the horizon, with the risks to Bank Rate skewed to the downside and new QE to be required in the event of a no-deal Brexit. Sterling, meanwhile, is now back up above $1.27, also up about 2 cents over the past two days.

Following the Fed’s pivot yesterday, all eyes in Japan today were obviously on the outcome of the BoJ Board’s two-day policy meeting. There were no surprises in the policy statement, with the key elements of the monetary policy framework predictably left unchanged. So, the -0.1% marginal interest rate on excess bank reserves was untouched, as was the commitment to purchase JGBs so that 10Y yields remain at around zero percent. There was also no change to the BoJ’s forward guidance, that the current extremely low levels of short- and long-term interest rates would be maintained “for an extended period of time, at least through spring 2020”. And the BoJ again pledged to conduct its JGB purchases in “a flexible manner” so that its holdings will increase at an annual pace of about ¥80tn, more than double the rate achieved so far this year. The usual two out of nine Board members – Kataoka and Harada – dissented from those decisions. By unanimous vote, the Board agreed to continue ETF and J-REIT purchases at an annual pace of ¥6tn and ¥90bn respectively.

The action, therefore, occurred in Kuroda’s press conference, where he emphasised that the BoJ wouldn’t hesitate to ease policy further if necessary. He tried to downplay the relevance of the +/-0.20% target range for 10Y yields, which has always been unofficial, featuring in Kuroda’s commentary rather than formalised in official BoJ policy statements. And he noted the importance of treating that range flexibly, seemingly giving the green light to a move in 10Y yields below -0.20%. But, of course, given its financial stability concerns, as well as its recognition that short-term rates have the greater impact on growth and inflation, the BoJ ideally wants to achieve an upwards-sloping yield curve. And Kuroda said that the BoJ might well take further action on the yield curve in due course. Looking beyond the JGB market, meanwhile, Kuroda noted that the BoJ wasn’t currently looking to increase its ETF purchases.

As for the policy statement, there were also no changes to the BoJ’s economic assessment, which was essentially a copy-and-paste job from the April Outlook Report summary. So, the BoJ continued to judge that Japan's economy “is likely to continue on a moderate expanding trend, despite being affected by the slowdown in overseas economies”. And with domestic demand still expected to remain on an uptrend, the Bank continues to expect annual CPI inflation to increase gradually toward the 2% target “mainly on the back of the output gap remaining positive and medium- to long-term inflation expectations rising”. As previously, of course, risks to both economic activity and prices are viewed as skewed to the downside with those associated with overseas economies judged to be “significant”.

Data-wise, today’s only release of note was the all-industry activity report for April. We already knew that industrial production rose 0.6%M/M and tertiary sector activity rose 0.8%M/M that month. Today’s data showed that construction activity had a strong start to Q2, rising 1.2%M/M thanks to a 5.0%M/M increase in public sector output while private activity fell 1.0%M/M weighed among other things by a decline of 0.7%M/M in private home-building. As a result, all-industry activity rose 0.9%M/M, a touch firmer than expected. However, as that represented the first monthly increase so far this year, all-industry activity remained down 0.1%3M/3M.

With the Fed and BoJ announcements out of the way, next in line will be the BoE, with its MPC’s latest policy announcement due at lunchtime (UK time) today. There will certainly be no change in Bank Rate, which will remain unchanged at 0.75% by unanimous vote. But the post-meeting statement and minutes will be closely watched for any amendments to the Committee’s guidance on future policy that previously stated “were the economy to develop broadly in line with [the] Inflation Report projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate”. 

Certainly, since the MPC’s last policy-setting meeting at the start of May, there has been a significant transformation in the mood in global financial markets, not least associated with perceptions of intensified downside risks to the global outlook, heightened geopolitical tensions, and those aforementioned rising expectations of a shift in Fed policy. And domestic economic data strongly suggest much weaker UK GDP growth in Q2, with our expectation for a small contraction. The political backdrop in the UK, including a Conservative leadership campaign that has seen no candidate propose a way forward on Brexit capable of being endorsed by both the EU and House of Commons, has further heightened the uncertainties surrounding the near-term economic outlook. As such, market pricing now suggests that the next move in Bank Rate will more likely be down rather than up. But while that might suggest that some adjustment to the MPC’s forward guidance might be in store today, data released last week implied that the labour market remains relatively tight. So, on balance, we expect no change in message today.

Data-wise, May retail sales figures are due this morning. Following robust growth in Q1, retail sales are likely to have weakened for a second successive month adding to evidence of a weak second quarter for GDP. On the political front, after yesterday’s vote brought the elimination of the sole realist candidate Rory Stewart, today brings the final ballots among MPs in the Conservative Party leadership election. None of the four remaining candidates has announced a clear strategy for Brexit that might be agreed with the EU. And all have proposed ditching fiscal prudence too. The final two candidates to be for submitted to a vote among party members will be selected by MPs today. And the unreliable populist Boris Johnson is bound to come in way in front, most likely with the uncharismatic Foreign Secretary Jeremy Hunt coming a distant second. Johnson, of course, remains odds-on favourite to move into Number 10 Downing Street next month. 

Euro area:
Today’s most notable economic data release in the euro area will be the Commission’s preliminary consumer confidence indicator for June. Having risen in May to a six-month high of -6.5, the consensus forecast is for no change in the current month. Politics-wise, the EU leaders will meet again later today for another summit, with the appointments to the top jobs at the EU institutions (including Draghi’s successor at the ECB) again on the agenda. But we certainly do not expect a meaningful breakthrough at this meeting, with a further summit on 30 June already set to try to reach an agreement. In the markets, finally, Spain and France will sell bonds of various maturities. 

In the US, as the dust settles on the Fed’s policy announcement (please see the comment from Mike Moran, Daiwa America’s Chief Economist), Thursday will bring the June Philly Fed survey, current account data for Q1, the Conference Board’s leading indicator for May, and the usual weekly claims figures. In the markets, the Treasury will sell 5Y TIPS.


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