- While the BoJ underwhelmed near-term easing expectations in the most confounding of manners, a detailed review of their policy statement in the context of preexisting cyclical and structural growth and inflation dynamics suggests incremental easing is likely to come in the not-too-distant future.
- Looking beyond the immediate-term TRADE duration, it’s safe to conclude that the potential for a protracted JGB “tantrum” has been dramatically reduced and the key implication of dramatically-reduced JGB “tantrum” risk is reduced upward pressure on U.S. interest rates.
- With respect to the Fed, if it looks like a dove, walks like a dove and coos like a dove – it’s probably a dove. Looking beyond the [likely] December rate hike guidance inserted into today’s FOMC statement, both the Summary Economic Projections and Yellen press conference offered a slew of dovish takeaways.
- Moreover, the confluence of their ongoing “data dependence” and our dour outlook for the U.S. economy and the labor market imply the 10Y Treasury yield’s intraday high of 1.73% may represent the peak of 2016 rate hike fears.
- All told, we reiterate our bullish bias on Treasury bonds and defensive (i.e. non-cyclical) dividend yields in the context of our “lower-for-longer” and #LateCycle slowdown themes, having likely just survived yet another round of [largely ungrounded] consensus fear of higher rates.
“Quantitative and Qualitative Monetary Easing with Yield Curve Control” = Hawkish Doves
Overnight the BoJ overhauled its monetary policy framework as part of its “comprehensive monetary policy assessment”. The most important features of the new program are as follows:
- The bank will target a wider yield curve via controlling the level of both short-term and long-term interest rates (specifically a 10Y JGB yield of 0.00%). It seeks to accomplish the latter by implementing fixed rate JGB purchases across the curve and extending the duration of its existing fixed-rate funds-supplying operations from 1 year to up to 10 years.
- The bank will adopt an “inflation-overshooting” commitment, in which it pledges to keep expanding the monetary base until core inflation has stabilized above their +2% price stability target.
- While the new yield curve target gives the bank more flexibility in the timing and duration of JGB securities purchases, there were no changes to the existing pace of monetary base expansion (i.e. ¥80T/year).
In the context of the aforementioned overhaul, the bank was clear to point out that it now has an expanded list of options for additional easing, including: cutting the short-term policy interest rate (now at -0.1%), lowering the long-term interest rate target, adjusting the composition of LSAP and accelerating the pace of monetary base expansion outright.
Moreover, in the context of Japan’s preexisting cyclical and structural growth and inflation dynamics, we think betting on incremental easing in the next 2-3 quarters is as safe a macro bet you can make. For more details regarding said dynamics, please see our 9/20 BoJ meeting preview titled, “#BeliefSystem Breakdown: Will Kuroda Tightrope In Whitey Tighties?”.
If all you did was eyeball the TOPIX or the TOPIX Banks Index – which were up +2.7% and +7.0% on the day, respectively – you’d say the BoJ’s policy overhaul was well-received by Japanese investors. But a more-than-cursory glance shows that the market closed with the USD/JPY cross at its highs. The yen has since rallied and is now up over a percent on the day – heading into the Fed statement (it’s whipped around, but remains largely unchanged since). Holding preexisting trading relationship constant implies an open on the order of down -3% for the broader Japanese equity market – i.e. a reversal of today’s gains.
Looking beyond the immediate-term TRADE duration, it’s safe to conclude that the potential for a protracted JGB “tantrum” has been dramatically reduced, given that the 0.00% 10Y JGB yield target represents a ceiling, rather than a floor in the context of the aforementioned economic gravity weighing on Japan’s sovereign yield curve. That 10Y and 30Y JGB yields backed up only +4bps and +1bps on the day to -0.03% and 0.52%, respectively, is supportive of this view.
In fact, we can envision a scenario whereby the BoJ is forced to dump bonds into the secondary market to prevent yields from forcefully breaching its target to the downside. In this scenario, it’s highly likely that the bank opts for a wholesale downshifting of its targeted term-structure of interest rates given that it is unlikely that they would want to be perceived by market participants as tightening monetary policy.
From a global macro perspective, the key implication of dramatically-reduced JGB “tantrum” risk is reduced upward pressure on U.S. interest rates – which themselves have backed up from their early-July all-time-lows as Japanese demand for U.S. Treasuries has waned amid rising funding costs in the FX market. And though the yield pickup on 10Y and 30Y paper is now at negligible levels from the perspective of Japanese investors, we view the BoJ’s long-term interest rate target as an effective cap on the long end of the JGB curve – which implies little spread erosion from here.
In short, the aforementioned dynamic implies Japanese demand for U.S. Treasuries should stabilize after crashing in recent weeks. On the margin, that’s positive for long end of the Treasury curve. As such, we are keen to reiterate our bullish bias on Treasury bonds and defensive (i.e. non-cyclical) dividend yields in the context of our “lower-for-longer” and #LateCycle slowdown themes, having likely just survived yet another round of [largely ungrounded] consensus fear of higher rates.
“The Case For a Rate Hike Has Strengthened, But We’re Content To Remain On Hold For Now” = Dovish Hawks
Earlier this afternoon the Fed pandered to consensus expectations of their September meeting being used as a springboard to set the stage for a December rate hike by inserting the following language (all incremental) into their policy statement:
“The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”
In her presser, Yellen reiterated that every FOMC meeting is indeed “live” from the perspective of “policy normalization”, but we side with the market in eschewing their 11/1-11/2 meeting as a real candidate given that it lacks December’s offering of additional “communication tools”, which are identical to today’s press conference and Summary Economic Projections.
Dissenting from today’s policy statement were Esther George, Loretta Mester and Eric Rosengren – all of whom were calling for a rate hike at today’s meeting; three total dissenters represented a directionally-hawkish increase of +2 over the July statement.
That and [inappropriately] labeling domestic economic growth as having “picked up from the modest pace seen in the first half of the year” is about where the hawkish takeaways end. Downward revisions to the “Dot Plot” and Summary Economic Projections, as well as Yellen’s dovish tone throughout her press conference all coalesced to render today a huge win for long bond bulls:
The “Dot Plot” Heads South (Again):
- Consistent with the trailing two-year trend, the FOMC’s infamous “Dot Plot” saw wholesale downward revisions across the maturity curve.
- The median forecast for the Fed Funds Rate at year-end 2016 among FOMC members was revised down to 0.625% from 0.875% prior – effectively implying only one rate hike for the year.
- The median forecast for the Fed Funds Rate at year-end 2017 among FOMC members was revised down to 1.125% from 1.625% prior – effectively implying a more gradual pace of “policy normalization” in the form of only two rate hikes for the year vs. a median projection of three prior.
- The median forecast for the Fed Funds Rate at year-end 2018 among FOMC members was revised down to 1.875% from 2.375% prior.
- Consistent with recent downward revisions to the neutral rate, the median forecast for the Fed Funds Rate in the “long run” was revised down to 2.875% from 3% prior.
Downward Dog Summary Economic Projections:
- The Fed took revised down its 2016 real GDP growth forecast to +1.7-1.9% from +1.9-2.0% prior.
- The Fed revised down its 2016 PCE price index forecast to +1.2-1.4% from +1.3-1.7% prior. The committee revised down the high end of its 2017 inflation forecast by -10bps to +1.9% and the low end of its 2018 inflation forecast by -10bps to +1.8%.
- The Fed revised up its 2016 unemployment rate forecast to 4.7-4.9% from 4.6-4.8% prior.
Source: Federal Reserve
Key Highlights From A Less-Than-Hawkish Yellen’s Press Conference:
- “I agree the projections for growth are slow and that reflects productivity growth likely to remain low for a long time. Slow productivity growth is a factor that influences the longer term normal level of interest rates.”
- “Inflation is running below our +2% objective and it is important that inflation gets back to the goal.”
- “The Fed wants the expansion to last as long as possible.”
- “Investment spending has been weak for some time -- part of it is oil, but we're not quite sure why.”
- “There is little risk to falling behind the curve in the near future so the FOMC can be gradual in its rate hikes.”
Don't Forget That "Data Dependence" = Lower Rates If We Continue To Be Right On the Data
In the context of everything highlighted above, it’s very clear that nothing has changed with the Fed’s propensity to err on the side of caution with respect to its policy normalization objectives. Assuming the Fed remains “data dependent”, we believe our dour forecasts for domestic economic growth will force policymakers to maintain their dovish bias (relative to expectations). To recap, those forecasts are currently:
- Q3: +1.1% YoY/+1.7% QoQ SAAR vs. a Bloomberg Consensus forecast of +2.8%
- Q4: +1.0% YoY/+0.4% QoQ SAAR vs. a Bloomberg Consensus forecast of +2.4%
- Q1: +0.6%% YoY/-0.8% QoQ SAAR vs. a Bloomberg Consensus forecast of +2.1%
With domestic economic growth slowing on a sequential, trending and quarterly average basis across the preponderance of key high-frequency indicators within our predictive tracking algorithm, we anticipate negative revisions to both consensus and official GDP forecasts over the intermediate term.
Whether or not the labor market deteriorates fast enough to pump the brakes on a rate hike in December is likely beside the point at this point. What we do know is that labor itself remains at a very asymmetric point in the context of the ongoing recession in corporate profits – a recession that we do not see ending anytime soon. That plus continued degradation in the broader growth matrix likely implies some accelerated pace of labor market deterioration likely into and certainly beyond year-end.
In short, it would be wise for investors to adhere to the old mantra of “don’t fight the Fed” in that our “lower-for-longer” theme has legs with respect to the intermediate term. They (i.e. policymakers) have repeatedly told you as much.
As we’ve said a million times, the most exploitable risk across global macro markets was always the Fed’s own forecasts and we think investors will benefit from continuing to take advantage of said projections on the long side of duration.