The latest central bank moves are in.
The US Federal Reserve gave us its view last night. It’s keeping rates on hold. Things aren’t as bad as they were, so it might think about raising them in June. Maybe.
And we got the Bank of Japan (BoJ) this morning. No move there, either. The market didn’t like that. The yen soared. Stocks plunged.
Like it or not, this lot have the most power to move the market right now. So what can we helpless investors deduce from the latest decisions?
Shanghai Accord or not, the result is the same
Until early this year, most people (not us, I have to say) thought that an ever-stronger dollar was an inevitability. The US was obviously the strongest economy, and the Fed was obviously going to keep raising interest rates.
So obviously, the exact opposite happened. The Fed decided to freeze its rate rises, and the dollar weakened.
What gives? One theory doing the rounds of the currency market right now is that central bankers put their heads together at the G20 meeting in Shanghai in February this year, and put together a “Shanghai Accord’. This is the idea that they all decided to co-ordinate monetary policy, with the overall aim of weakening the Chinese yuan by the backdoor of weakening the US dollar (to which the yuan is tied).
The idea here is that no one wants China to devalue massively, because that would unleash a wave of deflation across the globe. So Japan accepts a stronger yen, and Europe accepts a stronger euro, in order to help China get back on track and avoid greater damage to the global economy.
It echoes the “Plaza Accord” of 1985 where the world’s financial authorities got together and agreed to weaken an extremely strong dollar.
It’s an interesting theory. It might be true to one extent or another. It’s not as explicit as anyone sitting down and signing pieces of paper, but the odd diplomatic nod and wink when they’re all hanging around over canapés and cocktails – yeah, why not?
Equally, I’m not sure you need anything as explicit or conspiratorial as a “Shanghai Accord” to explain what has happened in the markets since then.
The Fed saw markets collapsing at the start of the year. It saw a massive devaluation by China as a serious deflationary risk. And like every other Fed governor since Alan Greenspan, Janet Yellen really doesn’t need much excuse to keep monetary policy as loose as possible.
So it was hardly stunning that the Fed rowed back from rate rises in the face of all that panic. And it did the job – the dollar weakened significantly. China has shown signs of (debt-fuelled) recovery. And Europe and Japan just have to suck it up, because they’ve already enjoyed massive devaluations over the last couple of years.
So informal agreement or not, the result’s the same. Question is: what happens now?
The next moves for the Bank of Japan and the Fed
Let’s look at Japan first. The BoJ rattled Japanese markets today by failing to do anything more (as if it’s not already doing a vast amount).
It’s an interesting move. The BoJ can’t be happy about the strengthening yen. And lots of investors thought it was bound to make a move today to do something about that.
So why didn’t it?
I think it’s because the BoJ needs time to come up with a better plan. The last time it got “radical” and imposed negative interest rates, the market did exactly the opposite of what the BoJ had hoped. Rather than bow down and sell the yen, we got yet another swathe of “central banks are out of ammo” articles.
So the next time the BoJ does something, it has to work. That means it has to be big. Maybe “helicopter money” big. And it’s much easier to “shock and awe” the market if the market’s expectations are low. So disappointing the market is all part of the plan.
They may also want to nudge the government into taking more action. There’s only so much a central banker can do, after all.
In short, I’d expect there to be more action by the BoJ later this year. But probably when the market least expects it.
As for the US – the Fed’s decision was pretty predictable. It sounded a bit more relaxed about the state of markets. But it qualified the whole thing enough to justify whatever it decides to do next.
The Fed’s window to raise rates again this year is narrowing rapidly. If it messes about with rates too close to the election then it risks being accused of political partisanship. Not ideal at a time when the Fed is largely seen as being firmly on the side of the global elites that everyone hates so much right now.
Yet, as David Fuller reminds us on fullertreacymoney.com, the Fed’s next rate decision comes right before the Brexit vote. The Fed might not give much of a damn, but it will be mindful of the risk of both sterling and the euro falling against the dollar if the vote goes in the direction of “Leave”.
What does that add up to? Don’t be surprised if Japanese stocks continue to struggle. But also expect to hear ever more desperate lines in the sand being drawn on the yen/dollar exchange rate.
And as far as the next Fed move goes – the only way the Fed will raise rates again is if the dollar behaves itself (stays below 100 on the Dollar Index) and if the US stockmarket doesn’t look too wobbly. So I’d still be favouring bets on a weaker dollar this year – which suggests that emerging markets, commodities and gold trades remain good bets for 2016.