Tuesday, July 31, 2018

Capital Markets: "BOJ Prepares for QE Infinity"

From Marc to Market:
The Japanese yen has been sold following the adjustments to policy and outlook by the BOJ that will allow the unconventional policies continue for an "extended period of time." Cross rate pressure and month-end demand have lifted the euro and sterling through yesterday's highs. A disappointing Q2 GDP report from the eurozone (0.3% instead of 0.4%) helped slow the euro's gains, while the preliminary CPI was firm. Reports that Canadian team was not invited to US-Mexico NAFTA talks today may be weighing on the Canadian dollar a little.

There had been much speculation in recent days over the BOJ's course, and it turns out that much of what was discussed found its way into policy. The BOJ announced several steps, each small, but together are a significant adjustment to policy. The zero target for the 10-year yield remains, but greater latitude was signaled, and rather than move in a +/-10 bp, a 20 bp movement will be tolerated. The negative rate will be applied to a smaller part of bank deposits at the BOJ. The ETF buying will continue, but as had been floated, the buying will shift more to the Topix from the Nikkei.

The BOJ cuts its inflation forecasts. This year's projection was reduced to 1.1% from 1.3%. Next year's inflation forecast was trimmed to 1.5% from 1.8% and in 2020 1.6% from 1.8%. Although the BOJ provided some explanation for the weakness in price pressures, like the entry of women and elderly into the workforce, the risk is that it still is too optimistic about inflation.

The BOJ updated its forward guidance. It indicated that the extraordinary policies are will be in place for an "extended period of time." This is a key way what the BOJ is doing is different than the Fed or ECB. The BOJ is not modifying its measures to gradually bring them to a halt. To the contrary, it is to allow them to be sustained for longer. The statement was issued under a title which sums up our assessment: "Strengthening the Framework for Continuous Powerful Monetary Easing."

The yen has been sold to its lowest level since July 20. The greenback has pushed a little above JPY111.50 in the European morning. A $456 mln option struck there is expiring today. There another $965 mln option at JPY112.00 and about $800 mln at JPY111.00. The euro has approached JPY131, which is an important retracement of the recent decline.

EMU economic news was mixed. The unemployment rate looked to have slipped to 8.3%, but the May estimate was reduced to 8.3% from 8.4%. Inflation was a touch firmer than expected. The headline rose to 2.1% from 2.0%, and the core rate rose to 1.1% from 0.9%. Disappointingly, GDP expanded by 0.3% in Q2, a little softer than the 0.4% seen in Q1. The year-over-year pace slowed to 2.1% from 2.5%.

While the euro is firmer, it continues to trade within the range seen last week on the day the ECB met. The high then was just shy of $1.1745. The euro has not been above $1.1750 since July 11. In addition to cross rate demand from the yen, we also see two other forces impacting the euro. First, month-end position and hedge adjustment are thought to be euro friendly. Second, and pointing in the opposite direction is the effect of today's Treasury redemptions, which the Fed uses to shrink its balance sheet. On such days, the euro has typically traded heavier.....MORE