The week ahead : It's not a case of what the Fed does but what it says, and as for the BoJ ...... well, they'd better do something.

Monday 25th July 2016

The week ahead: It's not a case of what the Fed does but what it says, and as for the BoJ ...... well, they'd better do something.

ref:- "Bank of Japan Under Pressure to Join in Abe's Stimulus", Wall Street Journal, online

Central banks will once again be the focus of attention this week although the two in question are facing very different scenarios, and will be judging the merits and timing of two very different courses of action.

Late on Wednesday, the US Federal Reserve will announce its decision on interest rate policy. Let's be clear here ..... if recent strong data and a comparatively subdued global reaction to the Brexit vote has got people thinking about rising US rates once again, there is virtually NO chance that it will happen this week. Actually there's something like a 4% chance according to Fed Fund futures, which is much the same thing (he said with fingers firmly crossed). All attention will be on Fed Chair Janet Yellen's statement, and on clues as to whether a hike before the end of 2016 really is back on the cards.

We said the other day that it does feel a bit that way, and respectable data rather than anything spectacular would probably be enough to tip the balance. More of a problem may be those pesky global headwinds that the Fed is obliged to bring into consideration these days. It's true that the markets have managed to take things like Brexit pretty much in their stride when it would have been perfectly reasonable to assume a much larger backlash was likely, but there are plenty of other issues in the pipeline, all of them capable of disrupting the best-laid plans. In approximate but not exact chronological order one might list a few of them :

**    Italian banks -- bear in mind that the results of their "stress tests" are announced on Friday. (By the way,  Mario Draghi sounded like he was suggesting that their predicament might merit the "exceptional circumstances" clause being brought into play, and that some form of state aid might be allowed? If so, is that a fudge by any other name?)

**    Italian constitutional referendum, some time in October. One POSSIBLE scenario is that PM Renzi loses the vote, an election is called, and the populist Five Star movement gain power (well, they are ahead in the polls). Currently, much of their rhetoric revolves around getting Italy out of the Euro

**    US Presidential election -- no one would say that a Trump victory is impossible now. The ultimate in populist swings would herald the kind of protectionist fervour that globalisation had seemed to rule out

**    Further elections in Germany, France, Austria. Will the UK's fate (whatever it is) discourage others from taking the populist route, as it seemed to in Spain?

One's got to be careful of assuming the worst, but policymakers will know that any one of these has the potential to upset the applecart.

  

So what about Japan? Their monetary policy decision comes on Friday and it would be fair to say that with PM Abe readying a wave of FISCAL stimulus (probably in early August and worth anything up to JY20 trillion by the highest estimates), most are expecting BoJ boss Kuroda to announce accompanying monetary measures. A cut in the headline interest rate from minus 0.1% to minus 0.2% maybe, or an expansion of the monthly bond-purchasing programmes? Very possibly both, and yet ..... there is a suspicion that although the BoJ is very likely to take some sort of action this time (expect some violent market reactions if they don't), some BoJ officials are coming round to the view that monetary policy has gone just about as far as it can go to boost growth and inflation. Negative rates bring as many problems as they solve, and just how much of the government debt should the central bank be allowed to buy?

The imminent announcement of a new package of fiscal measures is welcome, but what about the third "arrow" of Abenomics, structural reform? How about something that deals with Japan's antiquated labour practices for example, or seriously addresses the problems presented by a demographic black hole of the world's oldest population, a low birth rate and little immigration? Over the years the population has shown itself reluctant to spend, which fosters deflation and makes companies, on the whole still very profitable, keener to invest outside Japan rather than at home. Some stronger government action on that front would seem to be in order, but plainly that's for a later date. For now , we'll wait on the BoJ and their attempts to conjure something with increasingly little ammunition at hand.