US second quarter growth, released on Friday, came in well below expectations causing a rally in US Treasuries with the 10-year dropping 12 basis points to 1.45%. The US economy grew at an annualised pace of 1.2 per cent in the three months to the end of June, a modest acceleration from 0.8 per cent in the first quarter, but less than half the 2.5 per cent forecast by economists.
Last week, the FOMC maintained its interest rate status quo by holding rates again, this time round with one dissent. The only significant upgrade to the economic assessment was, “Near-term risks to the economic outlook have diminished.” This comment suggests the Fed is gearing up to resume the normalisation process, however there was little guidance that lift-off will take place at the next meeting in September. Friday’s GDP release will only complicate matters.
Only three meetings remain this year (September, November and December), with the US presidential elections in November we expect the Fed will want to wait until next year to begin its gradual interest rate tightening cycle. The futures market is not pricing in a hike until March 2017, while some market makers have pushed out their expectations for the next hike as far as June next year.
Growth or the continued weak state of it remains a continuing theme for global investors. Not surprisingly, Japan which is also grappling with negative structural trends (ageing population, lack of immigration, secular stagnation and the need for greater structural reform) is receiving a lot of attention as it is one of the furthest down the route of deploying unconventional policies. More questions are being asked about whether they are reaching the stage of deploying helicopter money, particularly following Ben Bernanke’s recent visit to Tokyo. Quite why central banks continue to adopt unconventional policies that have failed for the past 20 years, as has been the case in Japan, continues to surprise us, but it is quite obvious that unconventional policies are here for the foreseeable future.
Despite Japanese growth continuing to languish and the July inflation print remaining negative (-0.4 percent yoy) Haruhiko Kuroda, the Governor of the BoJ, has opted for a tamer approach instead leaving the monetary base expansion at JPY80tn per annum, negative rates unchanged at -0.1 percent, increasing ETF purchases to JPY6tn from JPY3.3tn and expanding the special dollar lending facility to USD24bn from USD12bn. So far comments from Haruhiko Kuroda, the Governor of the BoJ, appear to rule out helicopter money and the accompanying blurring of the institutional boundaries between central bank driven monetary policy and government and parliamentary determined fiscal policy. Last week he is reported to have said “I don’t think at all that either quantitative easing or our interest rate policy has reached limits” implying more of the same.
The announcement last week of plans for a JPY28tn (USD265bn or ~5.6% of GDP) fiscal stimulus package has also allowed the BoJ time to assess its policy. The details of the stimulus package are expected this week and the key issue will be how much of the headline figure is actually new spending and over what timeframe this will take place.
Nevertheless, the issue of whether the BoJ had already hit the limit in terms of JGB buying continues to be debated given that the BoJ owns ~37.4% of the JGB market and seems to be reaching some constraints in terms of liquidity. While shifting the yield curve into negative territory has reduced the cost of the government issuing/refinancing more debt it has hurt bank profitability, not boosted loan growth (2% yoy excluding trusts in June) or seemingly encouraged domestic consumption.
Elsewhere, as we highlighted last week, the IMF had cut its growth estimates due to a perceived negative impact from Brexit: their 2017 estimate for the UK was one of the larger downgrades being slashed by 0.9 percent to 1.3 percent. Any UK growth and investment forecasts now come with a lot of caveats and low confidence levels, although it looks like a near certainty that base rates will be cut on Thursday. Brexit, the rise of populist politics across Europe, the US election and unconventional markets quickly losing faith in central banks, our bias at the long-end of the curve has remained supportive of performance. We therefore remain comfortable with our high credit rated range of diversified portfolios which continue to offer ample spread cushion and attractive yields.