After the Fed, some "smoke and mirrors" from the Bank of Japan .....

Friday 18th December 2015

After the Fed, some "smoke and mirrors" from the Bank of Japan .....

Ref : "Humans Claim Win over Robots as BOJ's Late Decision Roils Market" , Bloomberg Online

You've got to give the Bank of Japan some credit for their timing at least ..... if you're going ease policy, or at least pretend to, when better to do it to gain maximum effect than just after the Fed has raised rates ? As it happens, the BOJ weren't really easing policy, it just looked that way for a moment. They did extend the scope of bond purchases by including bonds with maturities of 7 - 12yrs, rather than just 7 - 10yrs, but did not increase the amount of monthly purchases. They also allocated a small amount of extra cash for ETF purchases, but in essence this was a technical manoeuvre. All in all, it didn't amount to much but the market reactions were interesting.

As you might expect in the immediate aftermath of an announcement perceived to herald a further easing of policy, the yen fell and stocks gained. After only a few minutes however, once traders had been able to analyse what was actually said, these moves were reversed in double-quick time. The blame for the initial "misread" is being laid at the door of sophisticated algorithms that drive so much of trading volumes these days. Apparently, these algorithms are sophisticated enough to recognise and act upon headlines, but can't analyse the finer details. As regulars will know, this blog has often made clear its nervousness over the extent to which algorithms have taken over day-to-day trading (if not necessarily for this particular reason) and can therefore appreciate the irony of old-fashioned trading machines (i.e. humans !) getting one over the robots. The sad truth however is that the way forward in future will almost certainly be to devise better algorithms rather than to give back more responsibility to individual traders. Oh well, it was nice while it lasted ....

Another thing to emerge from the action in Tokyo this morning was some discussion as to how much central banks can achieve on their own to stimulate growth. We hope nobody meant "How much can they do to support asset prices?", but rather were putting central bank actions in context with other methods such as fiscal measures (government spending projects etc), a route Japan is already heading down. Nevertheless, coming just after one of the more momentous Fed rate hikes in memory it's an apposite question. And how are things today , post - Fed announcement ? The dollar rally seems to have run its course, which given how the rate hike was signposted is not surprising. Stocks too have given up some of their gains, but then there is nothing inherently bullish for equities about a hike save for the relief factor of getting it out of the way so that's not unexpected either. Bonds however remain strong .... but there's a logic to this too. Higher rates mean a stronger dollar .... which means commodities (mostly quoted in US$) are cheaper ..... which means inflation projections are lower ..... which is good for bond markets.

Ah, inflation ..... the key word this morning (and every other, it seems). The Fed's focus has concentrated on the inflationary implications of a tightening labour market, but upward pressures have stubbornly refused to manifest themselves and there's a feeling around that the Fed will watching other parts of the inflation equation more closely in 2016. If you're one of those who accept the Fed's "dot-plot" scenario that there will be 4 , 25bp rises in 2016, you probably believe that lower commodity prices (certainly not just oil) will gradually fall out of year-on-year calculations and that the production cutbacks forced upon producers will gradually work their way through into higher prices. It's a perfectly reasonable theory ..... maybe the so-called "doveish hike" wasn't so doveish after all. But since there are plenty around who believe that further hikes will materialise far more slowly, if at all, we can be sure of just one thing : 2016 is likely to be equally as bumpy as its predecessor.