The forex space has been waiting a long time for a plethora of monetary and policy reasons to once again ignite currency moves. For too long, central banks’ no-nonsense, low-rate approach had been curtailing currency ranges. The Federal Reserve’s end to tapering this week supported the buck as investors focused on a robust U.S. labor market and not the potential for higher rates. The Reserve Bank of New Zealand’s (RBNZ) dovish statement has the kiwi underperforming and finally, the Bank of Japan’s (BoJ) overnight actions have again sideswiped the market — all three have contributed to an interesting closeout to October. The net result has been a stronger dollar mostly across the board, higher equity prices, and a spike in U.S. yields.
Most things look rosy for the U.S. Even yesterday’s third-quarter gross domestic product data (+3.5%, quarter-over-quarter) shows that the U.S. economy continues to lead the global recovery. Despite deflationary challenges in the eurozone, and slower growth concerns in the emerging markets (China, Brazil, and Mexico), the U.S. has managed to register two consecutives strong quarters (second quarter +4.6% and yesterday’s +3.5%). Forever, the disappointing print in the first quarter of this year (-2.1%) will continue to be attributed to “transitory” factors.
U.S. Government Spending Distorts Economic Picture
The initial market reaction painted a healthy-looking picture. Nevertheless, digging deeper into the numbers, the big gain in government spending was responsible for much of the outperformance, while fixed investment, exports and imports all declined. Federal government spending broke a long string of declines by growing at a 10% rate in the quarter. Global investors continue to see the U.S. as the global economic beacon while other regions continue to struggle.
Central banks will continue to dominate the landscape this week and next. Midweek, the Fed surprisingly focused on the “robust” U.S. labor market. This could suggest that Chair Janet Yellen and company are trying to prep the market for a bigger change in December. One of the responsible roles for any central banker is to ease into a significant policy change. This helps policymakers eliminate any surprise shocks that could potentially harm an economy. The Fed does indeed need to get the market primed and ready for an eventual rate hike. The fruits of their labor are beginning to show with fixed income beginning to price in the first rate hike sooner than later.
After the Fed it was the RBNZ and they too flatfooted the market. Governor Graeme Wheeler kept New Zealand’s rates on hold at +3.5% for the second consecutive meet, but removed policymaker bias in favor of more tightening in light of the softer-than-expected inflation pressure. New Zealand’s inflation slowed more than expected in the third quarter, hovering close to the bottom of the RBNZ’s +1-3% desired range. The RBNZ indicated “a period of assessment remains appropriate before considering further policy adjustment.” It was only natural that the NZD would come under pressure with the dovish tone (NZD$0.7846).
Bank of Japan Shocks Markets with Unexpected Easing
By dropping no hints of imminent action, and instead playing down doubts over Japan’s economic price prospects, has allowed the BoJ to spring the biggest of Halloween surprises. Governor Haruhiko Kuroda likes to shock, as he is looking for the market’s biggest impact. Overnight, the BoJ unexpectedly announced additional stimulus measures that include upping its asset purchases total to ¥80-trillion from the previous ¥60-70-trillion target range. This is the first time in 18 months that Japanese policymakers have bolstered asset purchases; the bank’s +2% inflation target looks increasingly unattainable.
The BoJ lost its way ever since April’s consumption sales tax was introduced. The net result of a tax hike has only dampened consumer spending, further hindering the economic problems of the world’s third-largest economy. Interest rate divergence (U.S. less dovish, Japan dovish) is expected to have broad implications for investors and the market. With the BoJ moving in the opposite direction of the Fed, it should benefit Japanese exporters by weakening the yen further against the dollar (this week the yen has weakened from ¥107.65 to this morning’s ¥111.65). The news has sent the Nikkei benchmark to print a seven-year intraday high, while the dollar continues to find support.
Kuroda indicated that the bank has not run out of ammunition. He firmly rejected the notion that there is little the BoJ can do if the rate of inflation again defies policymaker’s objections. Perhaps more importantly, Kuroda insisted that the BoJ has not shifted back to an “incremental” policy change. Yesterday’s large policy expansion is considered a “pre-emptive” strike to hit the +2% inflationary target sooner. He insists it’s not about a weaker yen aiding exporters, or Prime Minister Shinzo Abe and the national sales tax hike next year. It’s all about hitting the +2% inflation target a tad earlier — a rather large reasoning pill for the markets to swallow!
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