Thursday, August 2, 2018

Capital Markets: "BOJ Surprises, BOE on Tap, Trade Worries Weigh on Stocks"

From Marc to Market:
The Bank of England meeting concludes a run of major central bank meetings over the past fortnight. The BOE is widely expected to join the Bank of Canada in raising rates. The Federal Reserve and the ECB were content to do and say nothing new.

The Bank of Japan signaled its willingness to accept greater volatility in its 10-year yield, which also currently means a steeper yield curve, and made small adjustments to minimize some of the unintended consequences. By doing so, coupled with its forward guidance, the BOJ underscored its commitment to maintain its broad course indefinitely.

However, the BOJ surprised investors today by buying 5-10 year bond even though the 10-year yield was well within the band at around 14.5 bp. The BOJ bought about JPY400 bln (~$3.6 bln). There had been some talk that the BOJ would slow the rise in yields if they moved beyond 15 bp. The purchases were also unusual in that 1) it was not conducted at a fixed rate as its other defensive operations and 2) it occurred on the same day that the MOF sold bonds of the same maturity, something the BOJ had indicated it would avoid. The BOJ is to buy bonds tomorrow are part of its pre-announced schedule.

The dollar has been confined to about a quarter of a yen range above JPY111.50. There is a JPY111.75 option for $435 mln and a JPY112 option for $1.8 bln that expire today. The 10-year JGB yield is little changed from yesterday at 11.5 bp, despite the intraday volatility.

China signaled with its fiscal and financial support that it would try to offset the economic impact of the US tariffs. In a dialectic way, this is an affirmation through negation, which is to say, that China by seeking to offset the impact, Chinese officials recognize that the trade pressure will remain. The reason it will remain is that China will not capitulate.

To the extent that the US trade team has experience, it is with Japan in the 1980s. What worked on Japan will simply not work on China. There are two main reasons. First, the US had more points of pressure on Japan, including but not limited to defense. Second, the US companies did not have a much direct investment in Japan. Foreign companies, in contrast, including US companies, played an instrumental role in Chinese economic development since the early 1980s. China is not only the largest trading partner for many Asian countries and emerging markets economies more broadly, but it is the largest or one of the largest markets for US icons like GM, Apple, Starbucks, and Boeing.

If a couple of aspirins don't get rid of your headache, will half the bottle work? US negotiators claim to be surprised that China to not capitulate to a threat of 10% tariff on $200 bln of Chinese exports. Trump threatened a tariff of $500 bln of Chinese exports, which is practically all the US imports from China. Do US officials believe that raising the 10% tariff to 25% will force China to give in to US demands?

Investors so far do not seem to be reacting consistently on a macro level to the trade tensions, but individual companies that could be hurt seem to have been punished by investors....