By Bryan Rich
June 14, 2016, 5:00pm EST
German yields (10 year futures) went negative today, but importantly didn’t close negative. We’ve talked about the important symbolism of this market. This is a big deal, especially the recovery into the close, finishing spot on the zero line heading into tomorrow’s Fed and tomorrow nights BOJ meeting.
The Fed decision is tomorrow afternoon. Remember Fed members went on a public campaign to build expectations for a June hike — a second hike in their nascent rate hiking cycle. Of course, it’s not a normal hiking cycle, but just the slow removal of emergency level policies that were in place to avert a global economic disaster and fuel a recover, albeit a very slow and weak one.
But now, as the vote in the UK on whether or not to leave the European Union has become increasingly questionable over recent weeks, the expectations of a Fed hike tomorrow have evaporated. With that, the weak job creation number at start the month came as a gift to the Fed. It gave them a credible reason to back off of their stance, even though the threat to global economic stability (the chance of a UK/Brexit shakeup) is front of the mind for them.
Remember, last September, the Fed had set the table for a first hike. They told us they would, and they balked. The culprit then was the currency devaluation from China which shook up global markets and sent stocks falling. The Fed didn’t hike. And that added even more fuel to the market shakeup. It warranted the question: Does the Fed have that little confidence in the robustness of the economic recovery?
So this time around, changing course again on the Brexit risk would have made them look weak and uncertain (as they did back in September). But influenced by the changing data (the weak jobs number) — the market this time has given them a pass.
If they were to surprise and hike at this point, it would likely be equally as harmful as it was back in September when they chose not to hike.
What’s the point? The Fed has made it clear all along that they need stocks higher. It’s a huge component in restoring wealth, jobs and broader confidence and stability. Anything that can derail that is very dangerous to the recovery, and the Fed knows it very well. So do central bankers in Europe and Japan.
With that said, as has been the case the past three Fed events this year, the main event for monetary policy isn’t in Washington, the main event this week is in Japan.
The BOJ has given us plenty of clues that more action is coming:
1) Even after three years of Japan’s unprecedented policy attack on deflation and a stagnating economy, the head of the BOJ has said numerous times that they remain “only half way there” on meeting their objectives.
2) As we’ve said, two key components of Japan’s stimulus program are a weaker yen and higher stocks — both assist in demand creation, growth and debt reduction. On that note, there has been talk out of Japan that they may increase the size of their direct ETF purchases (more outright buying of stocks).
3) There has also been talk out of Japan that the BOJ may start paying banks to borrow money from the BOJ (negative interest rates on loans) and may start buying high risk corporate debt.
To simplify it, below is the most important data for the BOJ. The yen and the Nikkei. Both are going the wrong direction for the BOJ. All of their work since initiating the second round of QE in Japan has been undone.
The Nikkei opened at 15,817 the day the BOJ surprised the world with more QE in October of 2014. After trading as high as almost 21,000 last year, the Nikkei closed today at 15,859. And the yen is already at a higher point against the dollar than it was when the BOJ boosted stimulus last – bad news for the BOJ.
We said this last month going into BOJ: “An aggressive response would surprise markets. That’s what the BOJ likes and wants, because it gives their policy actions more potency.” It didn’t come then, but we think we will see it tomorrow night, even though the market is betting on no change.
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