Last week started with asset markets on tenterhooks; awaiting monetary policy announcements from the BoJ and Fed. As we had expected the BoJ moved to steepen the JGB curve, by launching 'QQE with Yield Curve Control', or Quantitative and Qualitative Monetary Easing with 10-year yield cap at 0%, and the Fed maintained the status quo; leaving a hike in December on the table.
The BoJ’s shift in policy creates a lot more flexibility without actually doing much to immediately push inflation higher. The central bank seems to have quietly dropped the unrealistic 2 year timeframe for reaching its 2% inflation target, forward guiding that an inflation overshoot will be tolerated, broad yield curve targeting rather than allocated QE amounts and maturities and the further possibility of increasingly negative key rates. The BoJ do still have some tricks up their sleeve though the latest comments suggest that they, like the rest of the world, still regard ‘helicopter money’ as unviable. However, there is still the possibility they are already preparing to pull out a fourth arrow, at the very least promoting wage increases to be based on future inflation expectations rather than the preceding year’s measure. After all with full-time wages remaining flat for over two decades many feel it is long overdue. We don’t see Japan’s economy sinking yet but there are clearly still a lot of holes to patch up.
Elsewhere, the Fed 'struggled mightily with trying to understand one another’s point of view' said Fed Chair Yellen, adding however that 'most participants do expect that one increase...will be appropriate this year' and that the issue is about timing rather than hiking. Having risen to 61.2% on Thursday, market odds for a hike in December ended the week around the same level, at 55.4%. The Fed’s median forward guidance was revised to two rate rises, from three for 2017.
US employment appears robust and August’s inflation numbers surprised on the upside, although retail sales did retreat. So some might say that the case for a 25bp hike has strengthened, but it appears that as much as the Fed may wish to tighten it is concerned with the eventual global market turmoil; as markets continue to cling onto central bank mutterings and have thrown fundamentals out the window. We have seen demonstrations of this all month as Fed speakers have opined differing views and asset markets have swung. We also have the market's overreaction since the Fed announcement yesterday; the S&P bounced over 1% into the close, the dollar and US Treasury yields fell and gold witnessed its strongest rally in a fortnight. The FOMC committee continues to indicate a 'gradual' path to tightening and this is exactly what they are doing, surely 25bps of tightening a year IS gradual.
Risk-on sentiment immediately picked up after the FOMC unchanged policy announcement and most assets classes enjoyed a bounce over the week. The yield on the 10-year UST fell 7bps over the week and the VIX (volatility Index) plunged 20%. Holdings across our portfolios benefited from the risk-on sentiment, especially at the long-end of the spectrum. Qatar sovereign 6.4% 2040s bounced 3.5 points just short of all-time highs. The issue continues to offer very attractive risk-adjusted return including yield of ~17% with a comfortable 4 notch credit cushion, according to our proprietary Relative Value Model the bond could still rally another 20 points to reach fair value.
This week, market focus will turn to the US presidential debate; where Clinton and Trump are due go head-to-head in what might be the most tuned into TV broadcast in history; ~100m viewers. This is where we’ll get a real indication of where public opinion lies. The OPEC meeting, which begins today in Algiers, will also be watched closely. There have been rumors that Saudi Arabia has offered to freeze production at January levels, with Iraq stating the meeting could end with steps to tackle the supply glut; should be interesting to see what Iran’s stance is… we will not be holding our breath.