Risk relief for stock markets

The final wash up from this week's major central bank decisions is that the Bank of Japan has made its stimulus policy more sustainable for the long term while the Fed has signaled a rate hike this year but a very slow pace of increases beyond that. This is likely to see equity markets reduce risk premium over coming days.

The final wash up from this week’s major central bank decisions is that the Bank of Japan has made incremental changes that are likely to put its stimulus policy on a more sustainable basis for the longer term while the Fed has met consensus market expectations by leaving its policy rate unchanged but signalling the likelihood of a rate hike this year.

The Bank of Japan’s commitment to keeping monetary stimulus in place until it achieves a sustainable overshoot in its CPI target confirms that its stimulus program is likely to remain in place over the medium term. At the same time it is moving to make this program more sustainable by limiting the cost to banks and pension funds by putting a floor of around 0% on long term bonds. Ultimately, the policy of targeting a yield curve structure may also allow it to reduce its pace of asset purchases and maintain the policy for a longer period.

While the Fed has indicated a rate hike is likely this year, the dot plot projections for the medium term rate increases is converging further with more modest market expectations. 

The combination of these central bank decisions is likely to see equity markets remove some risk premium over coming days. While a Fed rate rise in December is likely, there is at least some risk that events may conspire to move out to next year, further slowing the outlook for higher rates. Markets also have increased comfort that, when they do occur, the pace of rate increases is likely to be pretty glacial for the medium term.

The ASX 200 has responded positively to the Fed decision and lower bond yields this morning. However, the stronger $A will be a dampener for some sectors of the market over coming days.