The US Federal Reserve continues to provide dovish guidance and is keeping its policy Fed fund rate close to 0% through 2023. It will maintain the pace of its pace of quantitative easing programme via its US$120bn monthly purchase of bonds, despite an economic growth outlook upgrade on its latest “dot plot” that projected US 2021 GDP growth to be at 6.5% (the strongest since 1983) from a prior projection of 4.2% in the December 2020 FOMC meeting.
In addition, the US labour market is expected to improve, with the median estimate for unemployment to decline to 4.5% towards the end of 2021, dipping further to 3.5% in 2023. The Fed downplayed the risk of inflationary pressures, and only expect a bump in inflation to 2.4% in 2021 before slowing to 2% in 2022, excluding food and energy. Interestingly, Fed chair Jerome Powell dismissed talk of “hawkish dissent” among Fed officials during his press conference, where it was noted that seven of 18 officials predicted higher rates by the end of 2023, an increase from five of 17 recorded in the December 2020 meeting.
In the nutshell, the Fed’s aim now is more inclined towards 'juicing' the prices of risk assets rather than pre-empting the risk of higher inflationary pressures, which may trigger a negative effect on the real economy. Risk assets responded with vigour, as the S&P 500 and Dow Jones surged higher by 0.29% and 0.58% respectively, to close at fresh all-time highs. Even the technology/growth sensitive Nasdaq 100 managed to erase its prior intraday loss of close to -1.5%, to end the US session with a modest gain of 0.38%.
Key Asian markets are also trading in the green at time of the writing, benefiting from the positive feedback loop. Japan’s Nikkei 225 is up 0.90%, China’s CSI 300 is 0.70% higher, Hong Kong’s Hang Seng Index is up 1.5%, Hang Seng TECH Index is 1.9% stronger, Singapore’s Straits Times Index is 1.2% higher, though Australia’s ASX 200 underperformed with a loss of -0.57%.
Next up will be the Bank of Japan's (BoJ) monetary policy meeting outcome on Friday, and this meeting is important as the BoJ will also release its latest review on its monetary policy toolkit, which consists of a massive amount of exchange traded fund purchases and a yield curve control programme. The last comprehensive review was done in 2016, where the BoJ introduced its controversial yield curve control programme that pegged the yield of the 10-year Japanese government bond (JGB) close to 0%.
Key BoJ officials have indicated in the past week that the upcoming monetary review will be “comprehensive”, which has raised expectations that a big policy change may be on the cards. The BoJ’s deputy governor, Masayoshi Amamiya, has commented that the review's outcome was to continue monetary easing, reducing the side effects of the BoJ's policy and to make its response to changing conditions more “nimble and effective”.
In retrospect, implementing the yield curve control programme to peg the 10-year JGB yield at 0% has hampered Japanese banks’ revenues via lower net interest margins. Hence from Amamiya’s comments on the “reducing the side effects”, the BoJ may tweak its yield curve control programme this Friday by allowing the 10-year JGB yield to fluctuate at a wider range. This implies a higher probability of more revenue for Japanese banks, which may see a further boast to their share prices (the Nomura TOPIX Banks ETF has gained by 31.45% year-to-date in 2021, outperforming the Nikkei 225 year-to-date return of 9.8%). This also reinforced the ongoing positive feedback loop into cyclicals/value stocks as banks/financials are part of this rotational theme play.
Also, allowing the 10-year JGB yield to fluctuate by a wider range may reduce the current rising yield spread between the US 10-year treasury and 10-year JGB, which is now at 1.57% (a level not seen since seen 30 January 2020). The recent steep rise in the USD/JPY of 436 pips, from its 23 February low of 104.92, has reached a key inflection/resistance zone of 109.30/85 (also the major descending trendline from the June 2015 swing high). So if such flexibility is implemented on Friday, the yield spread between the 10-year US treasury and JGB is likely to be narrowed, which in turn may see a potential multi-week bearish reversal on the USD/JPY Watch the minor support level at 108.15.