Investors fear that the BoJ won’t move and that the Fed will move

Yesterday I did a post arguing that “no news is bad news” when it comes to the BoJ, as markets know that more action is needed.  Today CNBC has a story that supports that view:

Since stunning the markets with unprecedented monetary easing in April, the Bank of Japan has taken a back seat, failing to offer solace to investors that have been rattled by violent swings in the country’s bond and equity markets.

According to Kathy Lien, managing director, BK Asset Management, the central bank’s “overconfidence” is to blame for the instability plaguing the market.

“They did nothing because they were stubborn and overconfident that their policies were enough to stabilize markets and the markets said no,” Lien told CNBC Asia’s “Squawk Box” on Friday.

(Read More: A Question Mark on Japan: Pimco CEO )

“This is Japan’s own doing, they had the opportunity to provide markets with a small dose of stimulus in the form of increasing asset purchases or even the maturity on fund supply operations and they did nothing,” she added.

Lien was referring to the BOJ’s meeting this week when the central bank failed to announce additional measures like increasing the maturity on its fixed-rate loan facility to two years from one year.

And yesterday I talked about how the Fed needed to refrain from tapering its bond purchase policy.  Here’s a NYT article that discusses the situation:

A TAP ON THE BRAKES The final theory is that Mr. Bernanke has in fact shifted his stance. While certainly not a hawk, he has intellectually moved closer to ending the asset purchases than people might realize. It is important to remember that the latest open-ended program was conceived at the end of last year, when there was great trepidation about the drag that fiscal retrenchment would have on the economy.

“Back in December, the Fed didn’t know if we would fall off the fiscal cliff,” said David Rosenberg, chief economist at Gluskin Sheff & Associates. “So it may have thought, ‘We’ll shoot now and think later.’ “

It turns out that, in spite of Washington’s budget battles, the economy has been quite resilient. For the economic conditions that exist right now, smaller purchases may be more appropriate. Some economists dispute this line of thinking.

For instance, they say the Fed isn’t going to taper when the inflation rate is declining as it is right now. But Mr. Bernanke may think that dip is temporary, particularly since some forward-looking indicators in the markets predict a rise in inflation. And some economists see strong signs that the latest round of bond purchases is having its desired effect and will lead to a stronger economy as early as the second half of this year.

Let’s talk about the third paragraph.  Instead of “It turns out that . . .”, it should read; “As market monetarists predicted . . . ”  And I’m one of those economists disputing the view that smaller purchases are appropriate.  The surprising strength of the economy this year is predicated on expectations of Fed stimulus.  If they don’t do it, then the economy could weaken.  Bernanke needs to remember the circularity problem.  When you promise something to help the economy, you can’t reneg on the promise just as the data shows that the Fed signaling has worked.

To summarize, recent market weakness is very easy to explain.  The markets believe that the BoJ needs to do more, and they had previously assumed that the BoJ had a “whatever it takes” approach.  Now they aren’t so sure.  The US stock market doesn’t believe (as strongly) that the Fed needs to do more, but they are strongly opposed to the Fed doing less.

As always; “It’s about expectations of the future policy path, stupid.”

PS.  Commenter Mikio Kumada has a more nuanced (and optimistic) look at the Japanese case.  I strongly encourage readers interested in Japan to take a look at his excellent comment.




6 Responses to “Investors fear that the BoJ won’t move and that the Fed will move”

  1. Gravatar of Scott N Scott N
    14. June 2013 at 09:49

    I agree mostly with Mikio except I think the market is correctly anticipating that the BoJ is going to lose its nerve due to rising bond yields. The latest BoJ minutes, released only a day or two ago, show this.

    The markets would have been fine if the BoJ wouldn’t have gone wobbly when yields popped. I think the Fed is also worried too much about bond yields. The central banks don’t seem to understand that higher growth – i.e., higher NGDP – will result in higher bond yields. They are surprised when this happens and begin signaling that they are having second thoughts.

  2. Gravatar of John John
    14. June 2013 at 10:26


    Which measure of inflation expectations do you think the Fed should be targeting given that they are targeting inflation expectations?

    Looking at TIPS spreads, a few questions pop out. Why would they be different? Are there arbitrage opportunities? Why are expectations higher 10 years down the road than 5 years? Why did 5 year expectations fall so much compared with 10 year TIPS spreads? It seems strange that longer duration spreads have higher rates. Anyway, here’s the graph.

  3. Gravatar of When will central bankers learn? | Historinhas When will central bankers learn? | Historinhas
    14. June 2013 at 12:46

    […] Scott Sumner has an interesting post. The summary: […]

  4. Gravatar of Mikio Kumada Mikio Kumada
    14. June 2013 at 13:01

    Scott N:

    The minutes do not show that the BOJ is going wobbly. They show that they BOJ is discussing things. The markets are going wobbly because they see the BOJ is discussing things.

    The reason I don’t yet think the BOJ is going wobbly is because, at the end of the day, they decided not to proceed with incremental measures. That happens sometimes.

    But the key to understanding this is included in the link that you posted:

    “While bond dealers normally play an important part as market stabilizers via risk facilitating and efficient price discovering, they have been rendered increasingly irrelevant by the existence of a single big buyer (the central bank) and a single big seller (the Ministry of Finance), with uncertainty surrounding the timing of BOJ operations also impeding their risk-taking capacity,” wrote the pair. “This increase in volatility has also triggered a vicious cycle in which VaR-driven selling by investors catalyzes further rises in JGB yields.”

    Remember that the April 4 decision constituted a massive regime change. It was the monetary policy equivalent of a coup d’état. It is Augusto Pinochet taking over the La Moneda, except that there is no violence involved and those backing the coup represent the majority in parliament, not the army.

    The Kuroda team on April 4, only days after taking over this old, proud, and conservative institution, decided to start buying 70% or so of the net JGB issuance, sending a strong global signal to markets overall, but injecting the fear of god to a local industry segment (the bond dealers).

    The bond dealers, as the comment suggests, were degraded to “irrelevance”, from being a profitable, cozy, and influential niche during the economy’s only bull market during the previous regime – the JGB market (OK, it was also a yen bull market, but luckily FX dealers don’t care about the direction of the exchange rate).

    In this context, it is rather a sign of BOJ standing it’s ground by not accommodating every wish of this segment.

    I am not saying that the BOJ will not make mistakes. I would prefer it if the BOJ communicates, as Lars Christensen suggests, in manner that clarifies it doesn’t fear higher nominal rates, and cares only about their level in relation to inflation expectations.

    But a regime change is a process of struggle, in which sailing is not always smooth. We live not in an ideal world of monetary policy model market participants, but in a very real complex social system, which includes the straight-forward self interest of industries and industry segments. That sounds messy and it is messy sometimes.

    But it doesn’t necessarily change the big picture of the regime change.

  5. Gravatar of Mikio Kumada Mikio Kumada
    14. June 2013 at 13:24

    Correction: the BOJ is actually buying more like 70% of gross JGB issuance, not net. It’s buying up the entire annual net issuance and then some.

  6. Gravatar of ssumner ssumner
    15. June 2013 at 13:49

    John, Not much time today. The 5 year rate (below 2%) is more informative than the 5 year rate five years out, will will always tend to be around 2% or a bit higher. The current 5 year rate reflects the current softness in NGDP.

    The GDP deflator is the best price index to target.

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