Wednesday brought a double gift for risk investors: the usual, as the Federal Reserve declined yet again to raise rates, and the exotic, as the Bank of Japan declined to carry on undercutting its financial sector.
The contrast between the supportive framework for asset prices and the disappointing outcomes for the economies in question is stark.
Japanese shares rose nearly 2% and bank stocks leapt 7% after the BOJ not only refrained from taking interest rates further into the negative but pledged to steepen the yield curve. The S&P 500 rose 1.1% and the Nasdaq hit an all-time high after the Fed remained on hold despite what it acknowledged as a strong labor market.
Acknowledging the obvious, Japan abandoned its target of raising inflation to 2%t in two years, opting instead for an open-ended commitment to keep doing what has not worked yet until inflation rises above 2%.
The Fed, divided by a 7–3 vote, with the minority wanting a 25bp hike now, appeared to be at cross purposes with itself.
“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,” the Fed said in its statement.
While the clear implication was of a rate hike soon, perhaps at the first post-election meeting in December, this confidence is hard to reconcile with its own projections, which show more and more evidence that the Fed is buying into the narrative of long-running secular stagnation.
The median projection for long-run economic growth in the US fell to 1.8%, marking the first ever such forecast below 2%. The Fed also cut its projections for where rates will end 2017 by half a point to 1.1% and by the same amount for 2018 to 1.9%.
Note that not only do three FOMC members want rate hikes now, there are three further whose “dot plot” estimate of appropriate rates show they favor no hikes this year.
“The committee is more split than it has been at any time in our memory. This split in views will make FOMC communication and action increasingly difficult this year. In particular, we believe that this level of dissent will make it difficult for the committee to keep the possibility of a December rate hike live in the minds of market participants and, indeed, households and businesses,” Michael Gapen and Rob Martin, economists at Barclays, wrote in a note to clients.
Strategically irresponsible
The remarkable thing - and this applies both to the Fed and the BOJ – is not the disagreement around policy but exactly how radical it has been forced to become and remain.
Markets put the probability of a December hike at just above 50%, demonstrating scant confidence that the Fed will be able to hike a second time even a full year after the first. Fed Board member Lael Brainard’s characterization last week of a “new normal” in monetary policy in which the asymmetric risk of an economic stall argues for only proceeding very slowly now seems much closer to consensus than it would have been in past months.
Similarly, the BOJ, saying it will seek to blow its own 2% inflation target to the upside, is trying to appear strategically irresponsible, willing to do the unthinkable for a central bank in order to obtain the otherwise unobtainable result of rising inflation expectations.
It isn’t that it’s wrong for the Fed to give labor a bit of time to fatten at capital’s expense, or for the BOJ to want consumers to fear an inflation many have never known.
Both of these outcomes makes sense in the bizarre world policy makers find themselves in, yet neither has a good track record of working to achieve the goals of strong growth and moderate inflation.
Both policy paths are also hugely supportive for asset prices and risk, at least in the short to medium term. That makes the best bet in all of this to be continued management of monetary policy in a risk-friendly way. The Fed may not hike in December and certainly will not if fallout from the election, or other issues, leads to a market set-back.
The risks for the Fed are of turning Japanese, hamstringing it from returning to normal. For the BOJ, as Japan is already in a long malaise, there is no doubling back in the direction of policy, only fine tuning.
Central bank decision days will continue to be a kind of secular Christmas, with investors playing the role of kids.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
