The Week Ahead: FOMC, BOJ and More

The last week of April is eventful. The Reserve Bank of New Zealand, the Federal Reserve and the Bank of Japan hold policy meetings.  The UK, eurozone, and the US provide the first estimates of Q1 GDP. Japan, the eurozone, and Australia report consumer prices, while the US updates the Fed's preferred (targeted) inflation measure, the core deflator of personal consumption expenditures.  

These events will not take place in a vacuum.  The backdrop is an improving tone in the global capital markets.  The difficult start of the year is in the rearview mirror, as emerging market equities fully recouped the earlier drop, as have US and UK equities.   The DAX, like the Nikkei and S&P 500 gapped lower on the first session of the year.  The DAX approached the lower end of the gap (10485-10743) last week.  The Nikkei will begin this week at its highest level since early February.  There is a gap from then as well, and the Nikkei entered that gap (17515-17684) while the gap from the start of the year is still 7%+ higher.  

Commodities are also higher.  WTI is at its highest level since early last December. Copper prices are almost 20% above the January low and are probing the year's high, an area last seen this past November.  The price or iron ore (at China's port Qingdao) has nearly doubled since December's low to push above $70 a ton before profit-taking ahead of the weekend. 

Various public and private measures of financial conditions have improved since the dark days of the first six weeks of the year.   The VIX returned to 2015 low set in July in the middle of last week (12.65%).  

China's markets have stabilized but the recovery there has been muted.  The Shanghai Composite is off 16.4% this year, and Chinese stocks are the worst performing in the world.  However, with the help of government efforts, the property market has stabilized.  As the distortions from the Lunar New Year celebration fades, it seems as if the stimulative measures are having a positive effect.  

The medium and long-term risks stemming from the continued dramatic increase in debt (CNY loans and total aggregate financing) does not escape notice.  This reinforces our concern that the way that China addresses its current challenges fertilize the seeds of the next crisis.  

We would be remiss in our overview of the international financial climate if we did not recognize that the US dollar has weakened by about 7.5% on a trade-weighted basis in 2016.  It is also important to recognize that despite the appreciation of the Canadian and Australian dollars (9.2% and 5.8% respectively) this year, officials in both countries have not protested.   Nor has the ECB voiced much concern about the 6% rise of the trade-weighted euro.   

We suggested that the G7 and G20 agreements not to pursue beggar-thy-neighbor currency policies is like an arms control agreement.  Although sometimes the edges may get frayed, the arms control agreement remains intact.  Japan may have ratcheted up its rhetoric, but the fact that it did not intervene reaffirms the agreement.  

China's yuan has weakened against the trade-weighted basket the PBOC created, but it has strengthened against the dollar.  However, it reached its best level at the end of March.  The consolidative phase of the first three weeks of April appears be ending, as the greenback finds better traction against the yen and euro.      Just like global equities have become less sensitive to the performance of Chinese shares, barring a sharp move, we expect that yuan depreciation in the face of a broader dollar recovery will not be as disruptive it was last summer.  

Recent FOMC statements have increasingly (confirmed by word count) put more weight on global developments.    The Fed will likely recognize the improvement in the global climate, but must acknowledge the soft patch US growth has hit.   

Trend growth in the US is estimated to be near 2%.  The US economy grew 1.4% at an annualized pace in Q4 15 (the initial estimate was 0.7%).  The day after the FOMC meeting concludes, the first estimate of Q1 16 GDP will be released.  The median of the Bloomberg survey is 0.6%, which incidentally is the also the rough midpoint of the Atlanta Fed GDPNow tracker (0.3% as of April 19) and the newly unveiled NY Fed GDP tracker (0.8% as of April 15).  

Fed officials will look through the vagaries of the quarterly movement in GDP.  Their confidence that the economy will return to trend growth and that its inflation target will be reached is based on the continued strength of the labor market.  This is still the case.  The closest thing to a real-time reading of the labor market is the weekly initial jobless claims.  Last week, which is the period of the survey for the national report, weekly initial jobless claims fell to new cyclical lows.  It is now at a level not seen since 1973.  Continuing claims fell to their lowest level since November 2000. 

The June Fed funds futures contract implies almost a 1 in 4 chance of a hike while a Wall Street Journal survey earlier in the month found 75% of economists expect the second hike in June.  It is in the Fed's interest to keep its options open and not commit to a June move.  The Fed's may upgrade its global assessment, while recognizing the slowing of the US economy is likely to be transitory.  

The Bank of Japan is in a difficult position.  Its aggressive unorthodox monetary policy has neither slain the deflation dragon nor put the world's third-largest economy on a sustained growth track. The introduction of negative interest rates has not prevented the yen's appreciation which will lower import prices, reduce the value of businesses' overseas earnings and investment income from portfolio investment abroad.    Japanese officials may have tried marshaling support for intervention to arrest the yen's rise, but the G7 were not supportive. 

Before the BOJ meets, it will likely learn that overall household spending resumed its decline in March after rising in February.  There were only two months in 2015 that overall spending was positive on a year-over-year basis.  The weak consumption is occurring side-by-side with full employment, with the unemployment rate remaining at 3.3% and the job-to-applicant ratio staying elevated at 1.28. Headline consumer prices are expected to slip back to zero from 0.3% in February.  The core rate, which excludes fresh food, likely went back into negative territory, while the measure excluding fresh food and energy may have held steady at 0.8%.    

The February all-industries report will be released before the BOJ meeting.  The Bloomberg survey (median) expects a 1.4% contraction, suggesting the economy continues to struggle.  Nor does it look like momentum has improved.     The BOJ will also see the March industrial production report.  A bounce is expected after a sharp 5.2% decline was seen in February.  The underlying signal, from the year-over-year rate, is worrisome.  The year-over-year pace of contraction may have accelerated from -1.2% to -1.6%.  The preliminary April PMI that was released last week fell to 48, which is a new record low for this three-year-old time series.  

According to a Bloomberg survey, 23 of 41 respondents expect the BOJ to take fresh action. There are three areas it can move.  First, the BOJ can cut the interest on excess reserves, which currently stands at minus 10 bp.  Second, the BOJ can cut interest rate for some loans.  The possibility that the BOJ would a negative interest rate loans to banks, like the ECB may if certain conditions are met under its new TLTRO program, what captured the market's imagination before the weekend. Third, the BOJ can tweak its asset purchase program.  

Almost half of those Bloomberg surveyed expect the BOJ to buy more ETFs.  A fifth expect more bonds to be purchased.  A fifth also expects a rate cut.   It is difficult to know how many expect a negative rate lending facility to be announced as idea has just begun circulating.  Still the possibility of negative lending rates is an innovation by the ECB and possibly the BOJ.  

When the BOJ moved at the end of January to adopt negative interest rates, it came as surprise to investors and policymakers alike.  Remember Kuroda had informed a television audience from Davos that this was not his intention.  Japan's G7/G20 partners were so taken aback that the most recent statements have called for greater consultations, which may have raised the bar for intervention.   Whatever the BOJ does in the week ahead may not catch the market as much by surprise.  Still, as of April 19, when the dollar approached JPY109.50 (from JPY107.70 the day before) speculators in the futures market had a record net and gross long yen position.  

The eurozone reports money supply, unemployment, final CPI and its first estimate of Q1 GDP.    The important part of the money supply report these days is with the growth in the private sector lending.  The ECB's recent survey found business lending conditions had eased, but household lending conditions tightened.  Unemployment is slowly falling and may have held at 10.3% in March.  It stood at 11.2% in March 2015.  

After a whiff of deflation in February and March, the preliminary estimate had CPI at zero in April.  The final report is expected to confirm this estimate.  The core rate may have eased from 1.0% to 0.9%.  The core rate has been stable.  It has averaged 0.9% over the past six and 12 months. The 24-month average is 0.8%.  

Although many economists bemoan the slow growth in the eurozone, it is not far from trend growth, which is estimated around 1.5%.  In Q4 2015, the eurozone grew 1.6% year-over-year.  In Q1, the quarterly pace may have picked up to 0.4% from 0.3% (in Q4 15), but the year-over-year pace may have slowed 1.4%.   

The UK is also expected to have grown by 0.4% in Q1 15.  It expanded by 0.6% in Q4 15, which is the average quarterly pace over the past three years.   The year-over-year pace may edge down to 2.0% (from 2.1%), which would be the slowest since Q1 13 and represents the fourth consecutive quarter of slowing.  As the UK economy has been gradually slowing, we are not convinced the slowing in Q1 was due to Brexit fears.   This may be more of an issue for Q2.  

The Reserve Bank of New Zealand makes its rate decision on April 27 (5:00 pm ET).  It is expected to leave the cash rate at 2.25%.  Recent economic data has been firm. Dairy prices are recovering.  CPI is rising slowly from its trough.  Rate cut speculation has receded, but many are not convinced that the easing cycle is over and have shifted expectations toward the middle of the year.  

Four emerging market central banks meet.  Brazil and Russia may stand pat (at 14.25% and 11.0% respectively).  Colombia began a tightening cycle last September (from 4.50%) and is expected to continue with  25 bp hike its overnight lending rate to 6.50%.  Hungary cut its base rate target by 15 bp in March to 1.20%.  The overwhelming majority from the Bloomberg survey sees another 15 bp cut.

Disclaimer