Which way will US, China and Japan move on rates and QE?

27th October 2015


Charlie Diebel, global head of rates at Aviva Investors, looks at what lies ahead in this week’s Federal Reserve and Bank of Japan central bank policy meetings…

The US Federal Reserve is between a rock and a hard place as it prepares to release the latest instalment in its year-long story about its intention to raise interest rates.

Recent chapters have been long on hawkish rhetoric but short on action, as weaker jobs data undermined the case for a 2015 hike in the world’s largest and best performing economy. Now, narratives from other central banks show increasing signs of divergence, raising debate about currency depreciation as a knock-on effect, and how it might influence the US tightening cycle.

The Peoples’ Bank of China continues to ease both monetary and fiscal policy, the Bank of Japan is widely expected to announce it will expand its QE programme at the end of the week, and the ECB has indicated it will pick up its bazooka again in December. All of the above suggests that rival currencies could weaken against the dollar, to the detriment of US exports. However, with much of the detail of peer policy still unknown, perhaps the one certainty we can expect from the Fed on Wednesday is more uncertainty about the precise timing of its first rate hike in a decade.

Fed unlikely to shock markets this week

Nobody really expects the Fed to hike rates this week, although the convening of an unscheduled press conference would undoubtedly imply markets are in for a surprise. With the chances of a shock seen as very slim, most investors are focused on arguments for and against a move in December. The US central bank’s dilemma is that while keeping rates on hold would weaken the dollar, it could also deepen concerns about the global slowdown and its potential effect on the US economy.

Many investors see the actions of the other central banks as a response to weaker global demand, which could further detract from the chances of a US rate hike this year. That assumption is somewhat questionable. Even with further stimulus, the case for a near-term US hike is more compelling, not less. That’s because the domestic economy is strong enough to shrug of external factors, which means keeping rates at historic lows is increasingly hard to justify.

Another weak US jobs report would put a December rise on the back foot

Any rate rise in December will depend to a large degree on payroll and household data released in November. The last two payroll reports were softer than expected, indicating 140,000 to 150,000 new jobs a month, compared to a previous clip of 200,000 to 225,000. The November payroll should be strong because it includes seasonal hires for the holiday period. Another weak report, especially if it is accompanied by an uptick in unemployment, would be enough to keep the Fed on hold until at least the first quarter.

Market reaction later this week will depend on the tone of language from the Fed. Any easing of the hawkish rhetoric could see shorter dated maturities pricing even more aggressively. The most likely reaction overall is a steepening of the front end of the curve.

Investors need to be vigilant to significant change in semantics

Investors should be vigilant to a wider and more significant change in semantics in the weeks up to 3 December. Though far from a given, such a move would indicate the Fed is preparing the market for an alternate ending to its 2015 story, which has so far steered towards a hike this year.

But for now, it will be the usual case of pouring over a subtle change of a few, or indeed a single word. Remember when Janet lost her patience?

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