The central bank fest ramps up

It's unsurprising that traders and investors have done little in European and US trade.

  • The S&P 500 traded in a range of 2150 to 2139, closing up 0.2%. 60% of stocks closed lower, with volumes modest at a 13% average over the past 100 days.
  • The US volatility index (VIX) closed up 2.5%, although it is still fairly cheap to hedge portfolios at current levels.
  • A slight bid has been seen in the longer end of the US fixed income curve, with the ten-year treasury down three basis points at 1.69%. Data wise, we saw August US housing starts at -5.8% and building permits at -0.4%, both worse than forecast, although the data had a limited market reaction.
  • The Bloomberg calculated probability of a rate hike today (4am AEST) remains at 22%, although I feel it is closer to 5%. Investment banks BNP Paribas and Barclays are getting the headlines as they are calling for the hike.
  • The Bank of Japan (BoJ) meeting is the only thing to watch in Asia and one can expect an announcement anytime between 12pm (AEST) and 3pm (AEST). There seems more chance that they cut the deposit rate further into negative territory (currently -0.1%) than increase its quantitative easing program. However, I would expect them to adopt a more flexible approach here. Rather than target an expansion of the monetary base at ¥80 trillion a year, we could see the bank adopt a range of ¥70 to ¥100 trillion – more below.
  • In the FX market, USD/JPY is the pair to watch through Asia today, with the options market showing implied overnight volatility at 35.00. There have been bouts in April, June and August where implied USD/JPY has been this high, which have come prior to other BoJ meetings. The market is expecting a large move today.
  • On the JPY crosses, the JPY bulls seem to be getting the upper hand, with EUR/JPY trading lower after yesterday’s break of the June uptrend. GBP/JPY would be my choice for expressing a bullish JPY view, but given today’s event risk, it’s really all about watching the pair into ¥130.00, where there is huge support. A daily close through here today means short positions will be the way to go. Shorting a closing break of ¥130.00 would be a high conviction trade.
  • AUD/USD traded in a range of $0.7565 to $0.7531 and looks fairly well supported on pullbacks. As detailed yesterday, I’ll turn more bullish (as a short-term trading view) on a close above $0.7567 (the 12 September high).
  • Given the overnight leads, there has been no real move in the SPI futures to talk of. The ASX 200 is likely to open unchanged and one can see limited moves in either BHP or CBA’s ADR.
  • US crude has found buyers on the back of a huge 7.5 million drawdown in the American Petroleum Institute (API) inventory report. This gives downside risks to the inventory build in tonight’s (12.30am AEST) official Department of Energy report, where consensus is for a 3.36 million increase. Last week everyone focused on the gasoline inventories, so keep in mind the market expects a 1.3 million drawdown in gasoline inventories here, which is bullish of crude.

It’s the calm before a potential storm. While many in the markets will be talking about the high profile split between Angelina and Brad, the real focus is how to deal with the Bank of Japan’s ‘comprehensive review’ of monetary policy. Then, after a period of trying to understand the medium- and even longer-term ramifications on the Japanese and global capital markets, all attention will turn to US monetary policy.

There is a debate in the market around whether the BoJ will take the deposit rate deeper into negative territory (from the current levels of -10bp). Even then it’s not clear if the JPY weakens or strengthens. The BoJ currently target various assets purchases which equate to the bank expanding its base money by ¥80 trillion a year. However, there are a handful of economists that believe they could increase the annualised pace to ¥100 trillion, although the consensus is that the bank leave the pace of asset purchases unchanged. Clearly expanding the monetary base more aggressively will promote JPY selling, whereas leaving it as it is could fuel fears about uncertainty around the sustainability of its quantitative easing program.

My own personal belief is that they will try and create a sense of flexibility and move to a range of ¥70 trillion to ¥100 trillion and portray to the market that the level of bond buying will be conditional on them reaching their inflation targets. This could result in an announcement from the bank that they may look at new assets to buy, such as infrastructure or local government bonds.

Stay safe out there, as the playbook and the range of market outcomes for both the BoJ and Federal Reserve meetings are diverse and have the potential to be game changing. If central banks are the only game in town, what we hear (or don’t hear) could have far reaching ramifications for financial markets.

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