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Bank of Japan cuts rates as a turbulent January comes to an end

As we head into the weekend and the end of the month most investors will probably be glad to see the back of January given the moves seen so far this year. While we have managed to recover some distance from the lowest levels the direction of travel from these levels still seems uncertain at a time when fears are rising that central banks are scraping around at the bottom of their so called monetary toolboxes.

This morning the Bank of Japan opened another chapter in the negative interest rate story when they unexpectedly cut interest rates to -0.1% in a move to try and kick start inflationary pressures in an economy that has consistently struggled to get out of second gear for years now. The move seriously divided the board by 5-4, suggesting much unease for such a radical move, though it only apply to new purchases under the ongoing asset purchase program.

The decline in commodity prices has certainly been a boon for net oil importing countries yet apart from the UK, there hasn’t been much evidence of a significant pick up in consumption in Europe or the US, though the official sales numbers in China have improved, assuming the numbers bear any relation to reality.

Oil prices have continued their recent recovery, posting their first successive three day sequence of gains since November last year, which would appear to bode well for some semblance of stabilisation.

While the move higher has been helped in no small part by vague chatter of some form of output deal between Russia and OPEC, without agreement from Iran which seems unlikely, there is about as much chance of that happening as Aston Villa winning the Premier League this year. The main reason oil prices appear to have found a base is a weaker US dollar, as well as some position covering heading into month end, which is helping support prices.

While oil prices headed north, European equities finished the day lower, dragged back by indecision about how to react to the changes in the latest statement from the US Federal Reserve, as well as some disappointing earnings updates from the likes of Deutsche Bank. 

There is no doubt that the economic outlook has become a little bit gloomier since December so a slightly more cautious statement was to be expected, and that’s precisely what we got, but it shouldn’t really have been a surprise that the Fed left open a decision about what to do in March.

No central banker is going to pre-commit to that extent, but investors should be able to read between the lines, and the removal of the lines about policymakers being reasonably confident that inflation will rise to 2% in the medium term, as well as a line about economic risks being balanced, is a huge clue that the Fed is a lot more concerned about the economic outlook than it was a month ago.

Throw in yesterday’s shocker of a December durable goods number along with the negative November revision and it would seem highly likely that today’s US Q4 GDP number is likely to be revised down from the initial reading we’ll see this afternoon.

Initial estimates are for Q4 GDP to come in at 0.8%, down from Q3’s 2%, with personal consumption dropping from 3% to 1.8%. The employment cost index for Q4 is also expected to remain steady at 0.6%.

It is quite likely, however that yesterday’s poor economic data won’t have made it into the first estimate, which means that the potential for a downgrade is likely to be fairly high.

Given that the next Fed meeting isn’t until March, the FOMC will probably prefer to wait to establish whether we see a decent recovery in Q1 data before they make another decision on rates, and given some of the weakness in some of this month’s manufacturing numbers that isn’t a given by any means.

After some fairly weak Empire manufacturing and Philadelphia Fed numbers earlier this month we get the latest Chicago PMI numbers for January. Last month the index cratered from 48.7 to 42.9, its lowest level since July 2009, and though we should see a slight improvement it is still expected to remain weak at 45.4. 

With the Q1 data unlikely to be anywhere near complete by the March meeting it would be a huge leap of faith to even contemplate another rate rise under those circumstances, and as such I would suggest a rate move higher in March is highly unlikely.

With the prospect of an imminent Fed rate rise receding undermining the US dollar, attention will shift to today’s latest flash EU CPI which is expected to see a jump to 0.4% for January, after yesterday’s positive German numbers, which could make Mr Draghi’s job in pushing the ECB further down the negative rate route slightly more problematic. 

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