Fed Holds, Japan Goes Negative

JapanResizeTwo big central bank decisions this past week sent the markets down one day and then blasted them higher at the end of the week. I am talking about the Federal Reserve and Bank of Japan announcements, of course. Although the market had different reactions, I believe both point to more central bank easing to come this year.

First, the Federal Reserve concluded its two-day meeting this past Wednesday, deciding to keep rates unchanged. In its statement, the Fed noted that recent data suggest labor markets are improving but economic growth has slowed, while inflation continues to run below their 2% target.

The rest of the statement was quite dovish, hinting at a more accommodative policy, especially noting that the committee is “closely monitoring global and financial developments.” This suggests the Fed is worried about the recent market turmoil and stock market declines in the U.S. and China. Somewhat surprisingly, the markets sold off a bit more than 1%, indicating traders either wanted even more accommodation or at least more clarity.

I previously noted that the Fed’s last rate increase was due to their concern about keeping credibility intact, rather than the Fed actually believing a recovery was under way. The latest move to stay put and not increase seems to confirm this. If economic conditions and data continue to deteriorate, we could easily see a move back to zero or even more quantitative easing. 

What is worrisome is that consumer prices, less food and energy, are now increasing 2% per year. Yes, food and energy are big components of household spending, so we can’t just ignore them. But energy markets are cyclical, rising and falling on supply and capacity excesses that are largely uncorrelated to general markets or inflation. Therefore, this tells us that everything is indeed seeing inflationary pressure, except for energy.

Japan Keeps Digging Itself Deeper

Meanwhile only a few days, ago the Bank of Japan denied the possibility of negative interest rates, only to completely catch the markets off-guard on Friday with the announcement of the implementation of negative interest rates! Technically, the Central Bank of Japan will only be imposing negative rates on new excess bank reserves deposited with the central bank, but the news was enough to send U.S. markets 2.5% higher to close out the month.

The market rally can only be attributed to a knee-jerk reaction because it does not make any economic sense. After suffering from heavy losses, market participants were likely looking for some hopeful news; the Japan news was not only a surprise, but some think the Fed and other central banks will be pressured into lowering rates. With the world’s third-largest economy now experimenting with negative rates, it also makes the policy less taboo.

Japan has been trying to revive its economy with Abenomics for some time now, using very easy money policies combined with fiscal stimulus programs to try to keep their economy out of recession. Readers of this blog know that money printing and government spending will not help an economy and will eventually make it worse. Further, the third part of Abenomics that actually had a chance to help – structural reform of labor laws and regulations – has not been implemented due to special interest groups and resistance to changing the status-quo.

The move by Japan may have a short-term effect on their markets and depreciate the yen further, boosting exports. But in the long-term, this will only hurt Japan; doing more of the same thing will not produce different results. Unfortunately, this also raises the stakes for the U.S. to keep rates low, and may even make negative interest rates look like a viable policy here in the not-too-distant future.

Chris Kuiper, CFA is currently a student and researcher at George Mason University, pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.

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