Unchanging Rates Lead to Changing Markets

May 2, 2016

Three major central bank policy decisions occurred this past week that followed in the footsteps of the European Central Bank’s (ECB) decision during the previous week. The three were, in chronological order, the US Federal Reserve, the Reserve Bank of New Zealand (RBNZ), and the Bank of Japan (BoJ). In summary, every one of these four central banks opted to keep interest rates unchanged. While this was expected for both the ECB and Fed, there was some prior speculation over potential further easing by the RBNZ, and certainly much anticipation that the BoJ would act with additional stimulus measures in attempts to halt the strengthening of the Japanese yen. In the end, however, non-action was the theme of the week, and it affected the markets in sometimes drastic ways.

The primary case in point occurred with the Bank of Japan. Despite the previous week’s reports that the BoJ was considering potentially more aggressive easing actions in the form of additional stimulus measures, which had led to an immediate drop in the yen, Japan’s central bank issued its decision on Thursday that it would hold off on any monetary easing. Interest rates remained unchanged and the BoJ was seen as taking the unexpected path of non-action, with nothing in the way of guidance or indication of any future action. This prompted an exceptional surge for the Japanese yen. This further strengthening of an already soaring yen is undoubtedly problematic for the BoJ, and continues to beg the question as to when the central bank will intervene with measures to weaken its currency. But it also presents the equally valid question of whether any intervention measures implemented by the BoJ would actually be effective in stemming yen strength. When the central bank pushed interest rates into negative territory in late January, the yen initially tumbled according to plan. Immediately thereafter, however, the currency embarked on a period of major strengthening for the ensuing months. The current situation appears to be similar, at least from a price action perspective. As of this writing, USD/JPY has plunged dramatically to drop below key 108.00 support as the yen has extended its surge and the dollar has continued to slide.

As for the dollar, the FOMC statement that preceded the BoJ decision was essentially a non-event. As expected, US interest rates were left unchanged. Aside from this, the Fed reiterated once again that its policy outlook will continue to be dependent upon economic data going forward, and that its pace of tightening would likely be gradual. The statement went on to provide mixed assessments of economic conditions, mentioning improvements in the labor market but a slowdown in economic growth indications. The one modestly hawkish aspect of the statement occurred not in its actual content, but in its omission of a key assertion from the previous statement in March. This time, the FOMC left out reference to global economic and financial risk, which indicated the Fed’s acknowledgement of a recent stabilization in world markets, especially when compared to the turmoil that occurred earlier in the year. Despite the fact that the FOMC statement did not introduce any new information, this omission of the key phrase on global risk was seen as somewhat of a hawkish signal that potentially increases the possibility of a rate hike at the FOMC’s next meeting in June. The immediate market reaction to the Fed’s statement was a spike in the dollar and a fall in gold, followed by a short period of whipsaw for both. In the following days, however, it became clear that the Fed’s consistently cautious stance could severely impede future rate increases, especially in light of a recent series of soft economic data releases, including Thursday’s weaker-than-expected US GDP report. This has placed significant pressure on the dollar, leading to a further downturn for the US currency.

To continue on with the central bank theme, the Reserve Bank of Australia will be issuing its rate and policy statements next week. Also of particular note will be several important employment data releases which could have significant bearing on central bank decision-making, including New Zealand early in the week followed by Canada and the US Non-Farm Payrolls simultaneously on Friday morning.

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