Market News | Amana Capital
The Bank of Japan (BoJ) yesterday published its semi-annual Financial System Report, which often gives insights into the longer-term thinking driving BoJ policy. This edition was no disappointment. We remain convinced that the BoJ is worried about the distortionary effects of maintaining a flat and low yield curve for too long.
In short, whether these USD maturity transformation trades are crushed depends upon the nexus between the Fed on one side, and the BoJ and ECB on the other. If the Fed continues to hike rates, but the BoJ and ECB keep policy on emergency settings, then portfolio outflows from Japan and the euro area will intensify, holding long UST yields down.
This will expose the USD maturity mismatch harboured by Japan's financial firms. Either way, we see the UST curve eventually steepening. The benign steepener would be if the BoJ and ECB were to follow the Fed up, at a distance. The less benign way is if the BoJ and ECB refuse to hike rates. Then the UST curve will continue to flatten until Japan's financial institutions are forced to sell their foreign assets, driving up long yields.
So the BoJ, for its part, can choose: Hike rates now and help to prevent a flattening of the U.S. curve, thus averting the full exposure of the foreign maturity mis-match in its financial sector. Or it can keep rates unchanged, helping to hold down long UST yields and squeezing its financial firms. Of course, the Fed could blink first and hold off from hiking rates, thinking that a curve inversion would be a sign of imminent recession.
But that certainly isn't our base case. We reckon that Governor Kuroda's rhetoric since late last year indicates that he wants to "adjust" domestic rates. He has been very careful to create a distinction between notions of "adjustment" and "exit". These types of concerns were enough to push the BoJ into surprising markets with its shift into yield-curve targeting in 2016. We have highlighted these issues since the beginning of our Asia Monitor, last summer.
We think they are now significant enough for the BoJ to surprise markets again by raising rates. If a fourth dot were to emerge from the Fed in June—our base case is September—that would be a huge boon to the BoJ, which we figure would use the opportunity to steepen the JGB curve by moving its 10-year yield target higher.
But we can't rule out the BoJ hiking rates regardless of the Fed dots. If the BoJ takes its own Financial System Report seriously, then at some stage it will have to bite the bullet.
ECB Plans to Wait Until July Meeting Before Announcing QE End – Bloomberg Cites Official Sources
According to a Bloomberg report citing official sources, the European Central Bank (ECB) plans to wait until the July meeting before announcing how it will end its QE programme. Governing council members want more time to ascertain whether the Eurozone economy is overcoming a Q1 slowdown. Any change to interest rate guidance would come later.
This report doesn't add much information. While some clue may come in June and not as soon at the upcoming meeting on 27 April, we expect, based on previous reports and signals the decision to be that bond-buying will wrap up by end-year.
Also, Bloomberg reported that ECB President Mario Draghi said Euro-area growth may have peaked; but growth momentum is expected to continue. Confidence in the inflation outlook has increased, though underlying inflation remains subdued. Patience, persistence and prudence is needed in terms of monetary policy.
The first sentence represents a notably downbeat assessment, but Draghi's other remarks are the same as before.
The Bank of Japan (BoJ) is set to keep its policy-setting unchanged at the April 27 monetary policy decision. We think it is still premature for the central bank to change its policy framework as inflation remains way below the BoJ’s target.
We expect that the central bank will keep its benchmark interest rate unchanged at record low of -0.100% and its yield curve control (YCC) near zero percent. The BoJ Governor Haruhiko Kuroda reiterated several times that the ultra-easing monetary policy will continue, while keeping the benchmark 10-year JGB yield at zero until 2% inflation target is achieved, which seems very difficult in the near-term for the central.
In its latest speech, Governor Kuroda, while speaking in Washington said that protectionism is a drag on Japan's economy for now. He said that however, does not expect protectionism to spread around the world. He added that G-20 is likely to engage in debate on protectionism as risks to global outlook.
Kuroda also said that rising protectionism is undesirable as it could hurt otherwise robust global growth and trade. Added that the G20 will likely discuss not just trade wars but geopolitical risks and how an earlier-than-expected monetary tightening could affect the global economy.
Next week, in the United States, key data releases are Q1 GDP, employment report, durable goods and home sales. Also, the European Central Bank, Bank of Japan and Riksbank monetary policy meeting will be closely watched.
Note: The FOMC will enter a blackout period ahead of their May 1-2 meeting this Saturday.
United States: Market estimate real Q1 GDP growth of 1.8% q/q annualized, a deceleration after three-quarters of roughly 3.0% growth. The employment cost index is likely to pick up in the first quarter, rising 0.7% q/q - above its Q1 reading of 0.6%. This would keep the y/y reading stable at its cycle high of 2.6%. Economists expect headline durable goods orders to rise by 3.5% m/m in March. Ex-transportation, economists expect orders to rise a solid 0.4% m/m. Existing home sales could decline 0.7% in March after rising in February.
Developed Europe: In the euro area, market forecast the composite PMI to rebound to 56.0 in April from 55.2 in March, with a recovery in both manufacturing and services. Economic confidence is likely to fall slightly to 112.2 in April. In France, markets forecast Q1 GDP to grow 0.4% q/q. Composite PMI should increase slightly to 56.6 in April. HICP inflation should rise to 1.9% y/y in April from 1.7% in March. In Spain, economists forecast GDP to grow 0.7% q/q in Q1. HICP inflation should edge down to 1.2% y/y in April from 1.3% y/y in March. In Germany, markets expect composite PMI to rise to 56.0 from 55.1, and IFO business climate to improve to 103.6 in April. Retail sales should increase 0.8% m/m (2.1% y/y) in March.
United Kingdom: Markets expect Q1 GDP to grow 0.3% q/q, but see downside risks of a 0.2% q/q print. PSNB ex should be GBP1.1 billion in March, compared to GBP2.1 billion in March last year.
Japan: Economists expect IP to be flat at 0.0% m/m in March after a 2.0% rebound in February and a -6.8% m/m plunge in January. Markets think that IP will be weaker than the results of the METI’s forecast survey suggest (+0.5%), because real exports shrunk by 1.7% m/m in March. Economists expect the unemployment rate to remain unchanged at 2.5% in March.
Central Banks: We expect the European Central Bank (ECB) to keep the policy and forward guidance unchanged. The tone of the press conference is likely to be similar to that in March, which might be taken as hawkish by the markets, we believe. We expect the Riksbank to leave the rate path unchanged and revise its medium-term inflation forecast upwards. We expect the central bank of Turkey to hike the late liquidity window rate by 50 basis points to 13.25%, but the recently-announced early elections increase policy uncertainty and the risks around our central scenario. We expect the central banks of Japan, Russia, Hungary and Colombia to be on hold.
Today, the Canadian dollar took a hit, and the USD/CAD rose from 1.2630 to 1.2731, as the growth in Canadian retail sales excluding autos, and Canadian CPI failed to meet market expectations.
Retail sales excluding autos were unchanged for the month, while economists per a Bloomberg poll anticipated a 0.4% growth. Annual inflation rose by 2.3% instead of the 2.4% projected.
Today’s batch of weaker data caused the Canadian dollar to soften, as it lowers the likelihood of further rates hikes by the Bank of Canada.
From a high of 35% in January the OIS rates markets have been lowering their expectations of three rate hikes by the end of 2018 to current 23.2%. Instead, investors are gravitating towards two more rate hikes this year, and the rate ending at 1.75% in December from the current 1.25% with a probability of 38.2%.
The rates markets give it a 38.8% probability that the Bank of Canada key rate will be at 1.75% at its December 12 meeting.
The USD/CAD maintains a bearish bias below the March 9 high of 1.2819, and as long as the price trades below this level I suspect traders will try to carve out a lower high. If the price indeed turns lower, I assume traders will target this week’s low of 1.2520, and possibly reach the February 16 low of 1.2446. However, a break to the March 9 high of 1.2819 could turn the trend bullish and therefore cause traders to target the March 2 high of 1.2945.
The European Central Bank (ECB) meeting and Mario Draghi press conference on Thursday. We won’t expect anything significant to be delivered next change will take place at the June meeting where ECB should remove the linkage between QE and inflation, and announce a tapering in 4Q18.
The ECB meeting Minutes from last week did not offer further insight. We noted that there was no discussion about de-linking the QE flow from the inflation objective. We continue to call for March 2019 based on current economic conditions actually would warrant an even earlier rate hike.
Thus, while our own ECB rate hike forecasts may appear hawkish relative to current market pricing, they are dovish relative to macro conditions. The CBRT, Riskbank, BoJ and CBR meetings over the week.