BoJ and BoE announcements in focus following the Fed

Chris Scicluna
Emily Nicol

Asian equities weaker as technology wobbles return despite supportive Fed
As had seemed likely, the Fed upgraded its economic assessment at Wednesday’s FOMC meeting, but issued a very dovish outlook for policy settings – one that was consistent with the changes to the Fed’s near-term policy strategy that was confirmed at Jackson Hole (more on the Fed below). The S&P500 was trading up modestly going into the Fed’s announcement and was up as much as 0.8% during Chair Powell’s press conference. However, stocks declined over the remainder of the session, pressured by renewed weakness in the technology sector, with the S&P500 eventually closing down 0.5% and the tech-laden Nasdaq falling 1.3%. In the bond market, the yield on 10-year Treasuries drifted a little higher as equities traded to their peak, only to reverse those gains as risk sentiment deteriorated. The return of risk-off sentiment boosted the US dollar against most counterparts, with the usual exception of the yen.

The risk-off tone continued in the Asia-Pacific region today with US equity futures declining by a further 1% and USTs reversing losses made following the FOMC announcements. This occurred even as President Trump made comments that appeared to indicate a willingness to accept a compromise US$1.5trn fiscal stimulus proposal negotiated by a group of Democrat and Republican lawmakers (whether it would pass through Congress is another matter, however). Most of the key regional benchmark equity indices are down between ½ and 1½%. In Japan the Topix declined 0.4%, with investors gaining little comfort from the BoJ’s slightly improved assessment of the economy (more on this below). In Australia the ASX200 fell about 1% and ACGBs gained despite a much stronger-than-expected August employment report, with even the Aussie dollar’s positive reaction to the figures proving short-lived. Equity markets were weaker still in Hong Kong, where tech stocks are down by about 4%. And European stock indices have also largely opened lower, but government bonds are mixed (consistent with the lack of risk appetite, Bunds have made modest gains, with BTPs weaker).

Fed more positive on economy but no rate hikes expected until at least 2024
Of course, the key event of the past 24 hours has been the conclusion of the Fed’s latest FOMC meeting. As was widely expected, the Fed retained its key policy settings i.e. its 0-0.25% target for the federal funds rate, its 0.1% interest rate on excess reserves and its programme of Treasury and MBS purchases. There were two dissents recorded in the post-meeting statement. The relatively hawkish Robert Kaplan preferred that the Fed retain greater policy rate flexibility to adjust policy as recovery takes hold, whereas the uber-dovish Neel Kashkari preferred that the Fed indicate that there would be no policy tightening until core inflation had reached 2% on a sustained basis.

As far as the outlook is concerned, as expected the Fed’s assessment of the recent performance of the economy was more upbeat than at the time of the last meeting in late-July. In the post-meeting statement activity was said to have “picked up”, rather than “picked up somewhat” as had been described previously. And the Fed’s formal forecast now points to a median expectation that the economy will contract 3.7%Y/Y in 2020, rather than the 6.5%Y/Y decline that had been forecast when projections were last published in June. However, partly reflecting that performance, the outlook for growth over the next two years – and especially in 2021 – is now weaker than had been estimated previously.

Still, given a much better than expected starting point, the forecast profile for the unemployment rate is much lower than indicated previously. The unemployment rate is now expected to end this year at 7.6% (vs 9.3% previously) and then decline gradually to 4.6% by the end of 2022 (vs 5.6% previously). The Fed’s first forecast for 2023 recorded an expectation that the unemployment rate will reach 4.0% by the end of that year – just below the assumed long-term rate of 4.1%. As far as prices are concerned, on both a headline and core PCE basis, inflation is expected to remain below the Fed’s 2% target at the end of 2022 (albeit slightly firmer at 1.8% vs 1.7% previously), only rising to 2.0% at the end of 2023.

Despite this slightly more positive assessment for both unemployment and inflation, the policy prescription remained very dovish, reflecting the adjustment to the Fed’s operational target that was confirmed at the Jackson Hole symposium in late August. In particular, the policy statement noted that the Fed expects that the current target for the federal funds rate will be appropriate until the economy has returned to full employment and inflation has risen to 2% and is on track to “moderately exceed 2% for some time” – what Powell described as “very powerful market guidance” with rates to remain “highly accommodative until the economy is far along in its recovery”.

Indeed, the Fed’s formal projections revealed that most Fed Board members and regional Presidents expect no policy tightening at all over the extended forecast period (just 4 of 13 members expected any degree of tightening by the end of 2023). And the statement again made clear that the Fed is prepared to ease policy further if risks emerge that could impede the achievement of the Fed’s goals. Cognizant of the current deadlock, Powell indicated that he expected that Congress would need to take further fiscal action to help bring the economy back to full employment. Please find the commentary from Daiwa America’s Mike Moran here.

Today will bring several US economic releases, including August housing starts figures, September’s Philly Fed business survey and weekly jobless claims numbers. Housing starts are expected to have slipped back slightly last month, likely reflecting some payback for the strong rebound seen in July rather than signs of a faltering housing market. The Philly Fed outlook index is also expected to have moderated somewhat. And the latest unemployment insurance claims data are out, with total claims (regular state UI claims plus special Pandemic Unemployment Assistance claims) having risen in each of the past four weeks. A broadly sideways move is expected today.

BoJ retains policy settings; upgrades economic assessment but wary of risks
Turning to the other G3 central bank meeting, as had been widely expected, the BoJ left policy unchanged in every respect when its latest Board meeting concluded today. So, its short-term policy rate was left at -0.1%, and the 10Y JGB yield target was left at around 0%, with only the usual one dissenter to the decision (Kataoka) from among the nine Board members. In addition, the upper limits for its purchases of ETFs (about ¥12trn), J-REITS (about ¥180bn), corporate bonds (about ¥10.5trn) and CP (¥9.5trn) were all left unchanged too.

As had also seemed likely, the statement accompanying the decision revealed an upgrade to the Bank’s outlook for the economy (although precise economic forecasts will await the next Outlook Report in late October). While the economic situation continued to be described as “severe”, reflecting the impact of the pandemic in both Japan and elsewhere, the economy was said to have “started to pick up with economic activity resuming gradually”. In particular, consistent with recent monthly reports, the Bank noted a pickup in both exports and industrial production. Private consumption was also said to have “picked up gradually as a whole”. By contrast, and reflecting revisions released in the national accounts, the Bank now assesses business investment to have been on a declining trend.

Looking ahead, as was the case in July, the Bank expects the economy to remain on an improving trend, supported by pent-up demand, accommodative financial conditions and the government’s economic measures. But, just like the Fed yesterday, the Bank acknowledged the major uncertainty about the outlook due to the unpredictable path of the pandemic. So, as was the case previously, the Bank noted that it will continue to closely monitor the impact of the pandemic and take additional easing measures if necessary, with both short- and long-term interest rates expected to remain at their present or lower levels. Of course, given the unfavourable cost-benefit analysis of further cuts, both the negative policy rate, and the zero percent 10Y JGB yield target are likely to be left unchanged for the foreseeable future.

The strong likelihood that rates will remain unchanged jars somewhat with the seeming inevitability that inflation will remain well below the BoJ’s 2% target, which – like the Fed – the Policy Board aims to overshoot. But in his press conference (which is still underway), Kuroda has insisted that the 2% target and overshooting commitment remain valid, and committed to taking further action – not least with respect to ongoing loan support – in an attempt to shift inflation higher. He also underscored that nothing has changed in the relationship between the BoJ and Government, despite Abe’s replacement as PM by Suga.

BoE also set to sit on side-lines leaving November MPC meeting to be key
The BoE’s monetary policy announcement, at noon BST today, is also likely to be a relatively low-key affair. With no new forecasts to be published, we certainly do not expect any changes to the main policy parameters. So, Bank Rate will remain at 0.1% and the asset purchase target will be kept at £745bn. The following meeting on 5 November – when the Committee will publish its updated projections and there could be greater clarity about the nature of the EU-UK trading relationship from the start of next year – will be the crucial one in determining the next steps for monetary policy. And we certainly still expect the MPC then to add an extra £100bn to the asset purchase target to sustain net buying of securities into 2021. However, as with the Fed and BoJ, the MPC might today judge that overall economic activity has been, if anything, firmer than expected. And inflation over the past two months has certainly been above its previous forecast. But it will also have to note further recent evidence that a marked deterioration in labour market conditions is underway.

In addition, of course, downside risks related to the UK’s future trading relationship with the EU have increased. That remains the case even though Boris Johnson and certain key Conservative Party backbenchers reached a deal yesterday to revise the Government’s controversial internal market bill. By appeasing many Tory MP rebels, the revisions would likely ensure safe passage for the Bill through the House of Commons. However, as they would establish a Parliamentary mechanism to give a green light to Government action inconsistent with the Withdrawal Agreement, the EU seems unlikely to be satisfied. Yesterday’s comments from Joe Biden and Nancy Pelosi warning the UK Government that there will be no UK-US trade agreement on their watch if the Good Friday Agreement – underpinned via the Northern Ireland Protocol of the Withdrawal Agreement – is not respected, could nevertheless prove a more effective stick than any legal moves from Brussels to force Boris Johnson to back down.

Australian labour market much stronger than expected in August
With the state of Victoria having returned to lockdown, investors were expecting to see some renewed deterioration in today’s Australian labour market report for August. But while Covid-19 developments in Victoria did weigh on the figures – employment in that afflicted state fell over 41k in August – nationwide employment still rose a very unexpected 111k, building on an upwardly-revised 119k increase in July and a 228k increase in June. Of course, even with these gains, employment remains over 400k below the pre-pandemic levels prevailing in February and down 2.6%Y/Y. Full-time employment increased 36.2k in August but remains down almost 300k since February. Perhaps not surprisingly, the recovery of part-time employment has been somewhat stronger, with such employment rising a further 74.8k in August to levels that are now just 118k below February’s level. Moreover, the ABS noted that most of the improvement in employment registered in August was due to gains in self-employment, with relatively little change in the number of employees. With the number of hours worked declining 4.8% in Victoria, aggregate hours worked increased just 0.1%M/M in August despite a 1.8%M/M increase in the remainder of Australia.

Whereas investors had expected Australia’s unemployment rate to rise above last month’s 22-year high of 7.5%, the strong increase in employment resulted in a 0.7ppt decline to a 4-month low of 6.8%. This decline occurred even though the labour force participation rate nudged up to a five-month high of 64.8% and despite a 0.3ppt increase in Victoria’s unemployment rate to 7.1%. The unemployment rate fell by 1.3ppts to 7.5% in Queensland and by 0.5ppts to 6.7% in New South Wales.

Importantly, this outcome is substantially stronger than had been expected by the RBA when it released updated forecasts in the last Statement on Monetary Policy in August. Indeed, the Bank had forecast the unemployment rate to end this year at 10%, declining only gradually to 7% by the end of 2022. A renewed rise in the unemployment rate cannot be ruled out over the remainder of this year with the Government’s JobSeeker and JobKeeper payments due to be scaled back at the end of this month (and with the latter scheduled to be further reduced at the beginning of next year). However, for now at least, there appears to be little in the latest data that would prompt the RBA to consider further easing measures. Deputy Governor Guy Debelle is scheduled to give a speech on the economy and monetary policy next Tuesday and it will be interesting to see his reaction to the latest figures.

Kiwi GDP contracts a record 12.2%Q/Q in Q2, much less than feared earlier
Across the Tasman Sea, today it was finally New Zealand’s turn to report on the impact of Covid-19 on economic activity during Q2. The national accounts revealed a record 12.2%Q/Q contraction in output, following on from a revised 1.4%Q/Q decline in output in Q2, leaving output down 12.4%Y/Y. Understandably, output contracted most in those industries that were most exposed to New Zealand’s severe lockdown restrictions and border controls. For example, output fell almost 44%Q/Q in the mining sector; 26%Q/Q in the construction sector; 25%Q/Q in the retail/accommodation sector; 39%Q/Q in the transport/warehousing sector; and 24%Q/Q in the arts/recreation sector. By contrast declines in output were much less severe in industries where work could continue from home. For example, output in the public administration sector fell just 2.8%Q/Q while output in the financial/insurance sector actually increased 0.7%Q/Q. By expenditure, the figures revealed a 12.1%Q/Q decline in private consumption; a 22.8%Q/Q decline in residential building and a 19.6%Q/Q decline in business investment. Net exports contributed 2.4ppts to growth, with a 15.8%Q/Q fall in exports exceeded by a 24.6%Q/Q slump in imports.

While hardly good news, today’s reported contraction in GDP was nonetheless slightly less than the market had estimated based on the available partial indicators. More importantly, the decline in output over the first half of this year was only about half as large as had been estimated by the RBNZ and Treasury back in May (and also less than these institutions had estimated more recently). In addition to demonstrating the resourcefulness and adaptability of firms and employees in dealing with the lockdown, the much better-than-expected performance of the economy substantially reflects the effectiveness of the government’s Covid-19 policy response – in particular the wage subsidy – and other relief provided by the RBNZ’s policy easing and banking sector. At face value today’s figures do not advance the case for further policy easing. However, the outlook for both fiscal and monetary policy will depend on incoming news regarding how the economy is rebounding in Q3 and beyond. The better-than-expected performance of the economy means that the Government still has substantial unallocated funds from its Covid-19 relief package (around $14bn, or almost 5% of GDP) while the RBNZ has made clear that it is prepared to ease policy further – including through adopting a negative cash rate – if that is required to achieve its inflation and employment goals.

Euro area car registrations predictably still highly subdued
In the euro area, this morning’s car registration figures predictably confirmed disappointingly subdued demand in August, down 17.2%Y/Y, the eighth consecutive year-on-year drop and a steepest pace of contraction than the 4.3%Y/Y decline in July. As had been previously published, the weakness across member states was widespread – i.e. Germany -20.0%Y/Y, France -19.8%Y/Y and Spain -10.1%Y/Y – although Italy outperformed with registrations broadly flat compared with a year earlier. But this followed marked weakness earlier in the year, with Italian registrations in the first eight months of 2020 down 38.9%YTD/Y, exceeded only by Spain (-40.6%YTD/Y), while year to-date registrations in France and Germany were down 32.0% and 28.8% respectively. So, overall, demand for euro area cars in the first eight months of the year was down by one third compared to a year earlier to 5.2mn units, the weakest year-to-date reading for August since the series began in 1989.

This morning will also bring final euro area CPI numbers for August. According to the flash estimate, euro area consumer price inflation fell further than expected last month, with the annual rate of CPI plunging 0.6ppt to -0.2%Y/Y, the first negative reading since May 2016. While that partly reflected the timing of the start of the summer sales and Germany’s VAT cut, it also underscored the disinflationary effects of the pandemic. And so the core rate also fell to a series low of 0.4%Y/Y. The final figures from each of the four largest member states aligned with their flash estimates and so we expect the same to be the case for the headline euro area numbers. Meanwhile, euro area construction output numbers for July are also due. Country data previously released showed construction output falling more than 4%M/M in Germany but rising 5%M/M in France.

ECB Vice President Luis De Guindos is scheduled to speak publicly later this morning after the central bank this morning announced that it would allow temporary relief to banks’ leverage ratios. In particular, the ECB said that, given current exceptional circumstances, it would exclude central bank exposures from the leverage ratio up to 27 June 2021.

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