Fed versus BOJ

A tale of two central banks…

It was a week in which both the key global central banks viz. the US Federal Reserve and the Bank of Japan maintained status quo on the monetary front. The global markets reacted to the Fed status quo in a fairly lukewarm manner while it reacted negatively to the BOJ status quo. Here is why…

Decoding the Fed status quo…

 The Fed decision to maintain status quo was never in doubt. The Fed had already indicated after its last meeting that it intended to hold rates till the time the global markets showed some real green-shoots of recovery. When the Fed hiked the rates by 25 basis points in December 2015 after a gap of 9 years, the global markets lost close to $12 trillion in market cap. This was accentuated by the monetary divergence between the US and the rest of the developed world. With the US following a tight money policy and the ECB and Japan following a loose money policy, the stage was set for a sharp spike in volatility.

This time around, there was no element of surprise in the Fed decision. The Fed futures had already priced in a very low probability of a rate hike in April and a fairly low probability of a rate hike in June this year. The US status quo was, therefore, hardly a surprise. With weak commodity prices, the US inflation showed no signs of getting closer to the 2% mark. The first quarter is likely to be one of the worst quarters for the US companies with a 9% fall in profits. Leading technology companies like Apple, Microsoft and Alphabet (parent of Google) are already feeling the pain of a strong dollar. The decision not to hike rates was almost a fait accompli.

Decoding the BOJ status quo…

The Japanese status quo was a little more surprising. Japan was expected to add to its already existing stimulus worth $732 billion with some more stimuli to boost liquidity in the system. Of course, with rates in negative territory already, there was little room for the BOJ to cut rates further into negative territory.

The big bet was on the strength of the Yen. Over the past few weeks, the Yen has been consistently strengthening. Despite negative rates of interest, the advantage is that Japan is a country with a current account surplus. Such a currency becomes an automatic magnet for portfolio flows as they are likely to benefit investors in terms of currency adjusted returns. The stimulus was expected to stem the strengthening of the Yen. However, Japan chose to analyze the outcome of negative rates before taking further steps. For the markets it means lower liquidity and greater tightness in the market. That is not great news for emerging markets which have got used to easy liquidity for too long since the crisis of 2008!  ©

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