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Central bank bonanza could lead to ‘Wild Wednesday’

Both the Federal Reserve and the Bank of Japan are expected to release monetary policy statements following two-day meetings and markets are increasingly concerned about what might be announced.

As was evident by the extreme reactions to the final two speeches from Fed governors ahead of the meeting, two weeks ago, it is clear that markets are not quite ready for another rate hike in the US just yet. Currently, the market is putting the probability of a hike somewhere between 10 and 20%, but questions remain over whether or not such a low expectation makes it more or less likely for the Fed to want to surprise markets.

In one camp are those analysts that believe the Fed is determined to prove it is not beholden to markets and thus, is more likely to hike in September than otherwise, because expectations are so low. In the other camp are those investors of the view that the Fed has no desire to lose credibility and so will not do anything to lose the markets’ trust.

Consensus seems to be on the side of the latter group, with most commentators expecting no change on Wednesday, but further hints of a hike later in the year. The caveat, of course is the timing of the US election, that all but precludes a hike in November in the eyes of most investors, but as has been seen repeatedly in recent months, consensus in any regard cannot really be counted on.

The Bank of Japan

Of more importance at present is what the Bank of Japan intends to do. After surprising markets in January by moving its deposit rate into negative territory, the BoJ followed this up with what many commentators characterised as an underwhelming stimulus package in July. Since that point yields on 10-year government bonds have surged, pushing prices to a six-month low last week, according to the Financial Times.

Concerns are that, should the Bank of Japan indicate it is considering significantly changing the nature of the ongoing stimulus it is providing to markets, or perhaps worse, begin to pull back on that lever, bonds could react poorly.

As Ben Bennett, head of credit strategy at Legal & General Investment Management, pointed out on Monday: “Their credibility has been undermined, and there is a strong possibility that the yen strengthens following any policy change, undermining their ability to boost inflation. Government yield curves have started to steepen in recent days, and a continuation of this could undermine the Goldilocks environment. Furthermore, corporate bond supply has picked up in September and could lead to temporary indigestion unless inflows remain strong.”

tom@ybc.tv

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