Global markets are holding their breath before the critical Bank of Japan (BoJ) and Federal Reserve (Fed) monetary policy verdicts.
Activity is expected to remain quite before a potential storm.
The Bank of Japan has a hard task given the markets expect a lot from the BoJ. Since the Prime Minister Shinzo Abe launched his merciless Abenomics programme to boost growth and to fight a decade old deflation, the Bank of Japan regularly surprised the markets by massive monetary actions.
Although inflation in Japan temporarily picked up over the months following the massive monetary easing and on the back of a sharp depreciation in the yen, the monetary action per se remained insufficient to trigger a healthy and sustainable growth. As soon as the second part of the Abenomics, the fiscal consolidation, was activated, the deflation returned and never left.
In fact, the fiscal consolidation proved to be incompatible with the massive monetary action, given that it neutralised the benefactions of cheap liquidity.
Today, the Bank of Japan stands at the starting point, with however a massive balance sheet on its shoulders, a deflationary market and insatiable investors.
What to do?
One thing is sure: it is very difficult for the Bank of Japan to surprise today’s markets. Investors have built high and undefined expectations vis-à-vis the BoJ policy, while the BoJ has an increasingly narrowing maneuver margin.
The BoJ’s attempt to purchase alternative asset classes, as the ETFs, has lacked the market’s support at the previous meeting.
Deeper negative rates could be an option. Nevertheless, the negative rates have barely given the discounted result. In contrary, the yen appreciated by more than 15% since the BoJ launched the negative interest rate policy (NIRP).
The inefficiency of the NIRP is due to Japan’s historical consumption dynamics and its aging population. In fact, the negative rates weigh on Japanese households' savings and pension funds, hence hold a major part of the population from spending. Therefore, the extended period of negative rates should continue weighing on inflation dynamics and further harm the economy. Despite the visible negative impact of the negative rates in Japan, many analysts continue believing that deeper negative rates are the way to go.
Else, the BoJ could extend its asset purchases overseas. The latter appears to be a reasonable shot. The market reaction will depend on the allocation and the financial risks associated.
How much additional risk is the BoJ ready to take given that the efficiency of its monetary policy has fallen short of the costs?
We doubt that it is soon time for Mr. Abe’s government to step in the picture, once again.