The Bank of Japan (BoJ)’s adoption of a negative interest rate policy framework to
close out January proved to be the kindling U.S. Treasuries needed for another break
lower in yields in February as 10y yields traded as low as 1.53%. This move back
lower in yield may not have been driven as much by the impact of the rate cut on
valuation as much as it was by realization that negative interest rate policy may have
more staying power than initially thought. While there are 13 countries with 2y rates
trading at richer levels than 2y Japanese Government Bond (JGB)’s, the move to
Negative Interest Rate Policy (NIRP) by Japan may have been the most meaningful
move since the Swiss National Bank (SNB) was the first major central bank to breach
the zero bound in early 2015. By showing financial markets globally they are willing
to punish their own population of savers to increase the velocity of money, which
has fallen to a 50-year low, yield seekers will have to look elsewhere, similar to the
message sent by the SNB. As global yield curves rally into negative territory it is
worthwhile to remember that U.S. debt makes up 47% of all outstanding developed
market debt that still trades with a positive yield, which makes U.S. Treasuries among
the most attractive safe haven debt instruments globally.
As their global counterparts seek to find the limits of expansionary monetary policy,
the FOMC spent February backing away from their own tightening bias for the
near term. For her part, Chair Janet Yellen gave her Semiannual Monetary Policy
Report before both Congress and the Senate early in the month. Though the Chair
was noncommittal on the future path of interest rates, she had clearly taken notice
of the tightening in financial conditions that had taken place in 2016. Despite her
acknowledgement of tighter financial conditions, she explained that she doesn’t
see tighter conditions as being persistent but would adjust her growth and inflation
outlook if that was indeed the case. Ultimately, the tone and text of the testimony did
not show a Fed Chair who was ready to continue on a path to tighter policy; instead
she appeared content to wait on economic data to paint a more complete picture.
Notwithstanding Chair Yellen’s lack of clarity regarding the future path of monetary
policy, other Fed speakers were more willing to share their views on economic
developments of early 2016. The loudest voice came from St. Louis Fed President
Bullard, who stated that he regarded it as unwise to continue a normalization
strategy in the face of falling inflation expectations. In the past, Bullard has been
the FOMC’s resident pragmatist, frequently recognizing the need to adapt his own
views to changes in the macro landscape before his FOMC colleagues. Most notably,
President Bullard was the first Fed member to utter the phrase QE2, well in advance of the implementation of the policy in the fourth quarter
of 2010. Similarly, Vice Chairman Stanley Fischer voiced
similar albeit less forceful concerns about potential drags
of financial conditions on global growth and inflation in a
speech at an energy conference in Houston. To round out the
central bank’s market communication for the month, FOMC
Governor Brainard spoke on international monetary policy
synchronization at a U.S. monetary policy forum in New
York. Governor Brainard also broke away from the FOMC’s
four hike in 2016 consensus saying, “Although the U.S.
real economy has traditionally been seen as more insulated
from foreign trade shocks than many smaller economies,
the combination of the highly global role of the dollar and
U.S. financial markets and the proximity to the zero lower
bound may be amplifying spillovers from foreign financial
conditions.” This recognition that measures of U.S. economic
health do not just manifest themselves in the real economy
but in global financial markets is an important development
for the Fed who may have been too myopic in their prior
assessments of U.S. health. While a strict framework of purely
economic indicators may have been sufficient in the past; the
relatively newfound connectivity between global central banks
and asset markets throughout the risk curve has changed the
necessary calculus for setting monetary policy. If the ability to
further tighten policy continues to come at the cost of falling
asset prices that may push growth and inflation expectations
down further still, it seems some FOMC members are now
willing to back away from the table.
The FOMC may be backing away from their easing bias at just
the right time as the U.S. is now the only G-10 country with a
futures curve implying hikes, and not cuts. The unintended
consequences of even a mild hiking bias from the FOMC
under current conditions could have an outsized impact on
the dollar which would hamper growth and inflation readings
as U.S. trade becomes less competitive still. It is because
of this circular logic that it appears the Fed will be stuck in
neutral in the coming months as rate adjustments in either
direction may cause more harm than good. Indeed, market
pricing did rebound from mid-February lows to end the
month implying two thirds of one hike in 2016 tightening
and a three in five chance of another the year following. This
marks the first time since mid-January that 2016 expectations
have surpassed 2017 hiking expectations in terms of quantity
of hikes per year.
While February had fewer direct market catalyzing events than
January, there is an ongoing, palpable change in sentiment
towards central bank policy action. No longer are monetary
stimulus measures met with markedly higher equity prices
and steeper FI curves, instead further stimulus has generated
a risk off feel as of late. The case of the recent BoJ policy
action is an instructive example of this paradigm shift.
While the policy move by the BoJ should have weakened the
currency as dictated by wider interest rate differentials, the
yen rallied significantly as market participants were willing to
challenge the BoJ’s ability to materially weaken the currency
further. Not only does this market rejection of policy action
significantly undermine central bank credibility but it also
leaves countries with high levels of debt without a way to
reduce the debt burden via inflation or growth. Nations like
Japan, which has a debt burden in the order of 2.5x GDP,
can ill afford to allow falling growth or inflation to increase
the debt burden in real terms at this point in the business
cycle. If asset markets continue to reject further central bank
policy easing, it will rest on their fiscal policy counterparts
to shoulder the load. However, expectations should remain
tempered in that regard as fiscal policy makers globally have
proven unwilling to take the mantle from their monetary
policy counterparts.
Source: Bloomberg
Source: JP Morgan
Global 10yr Yields
Source: Bloomberg
Goldman Sachs Financial Conditions Index
Source: Bloomberg
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