Hiatus In The Dollar Bull Market

The latest Global Investment Strategy report is entitled “Hiatus In The Dollar Bull Market”, and examines why the greenback has sold off this year and what the path forward is. The Weekly Report also discusses the Fed and the U.S. economy, the BoJ, and China, namely arguing the following points:

  • The FOMC statement underscored the Fed’s willingness to take a ‘go slow’ approach to raising rates. While a June rate hike looks increasingly unlikely, a September and December hike remain in play.
  • The lagged effects from the easing in U.S. financial conditions over the past few months should boost growth in the second half of the year. Diminished labor market slack is also likely to put upward pressure on wages.
  • The BoJ’s reluctance to admit that NIRP has been a flop so soon after it was launched helps explain why it failed to provide more monetary support at this week’s meeting. We expect a new round of easing measures this summer.
  • Chinese stimulus efforts should last a few more months, after which time commodity prices will resume their structural downward trend.
  • As such, while the greenback could weaken over the next few months, this will simply be a hiatus in the dollar bull market.
  • Investors should remain tactically bullish risk assets for now, but be prepared to shift to a more cautious stance in the second half of the year.

To access the report entitled “Hiatus In The Dollar Bull Market”, please click here.

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Investors Left Shocked And Awed By BoJ Inaction

By standing pat, the Bank of Japan delivered a different kind of “shock and awe” overnight. Clearly, expectations were running high that Governor Kuroda would introduce another large stimulus program. Despite the bravado displayed by Kuroda, the BoJ really does not have many options at the moment.

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The BoJ is currently buying ¥80 trillion of JGBs at an annual rate, more than double the net issuance of ¥30-40 trillion. The central bank is on track to hold nearly 40% of the outstanding stock of JGBs by the end of the year. One reason that the BoJ has been able to almost seamlessly purchase so many JGBs in the last three years is that GPIF, the public pension fund, has been unloading government bonds as it diversifies into riskier assets. However, the GPIF’s asset re-allocation is largely complete now. This will make it more difficult for the BoJ to continue its current pace of JGB purchases, let alone increase them substantially.

For the BoJ to boost the pace of bond purchases, there needs to be a concomitant easing in fiscal policy that leads to a greater net issuance of JGBs. This seems unlikely with the government still committed to increasing the VAT next year. Even with a supplementary budget for rebuilding following the recent earthquakes, there is unlikely to be a significant net easing in fiscal policy.

As for other asset purchases, they are simply too small to matter. The BoJ is buying ¥3.3 trillion of equity index ETFs and ¥90 billion of J-REITs. Even doubling these purchases will amount to less than ¥4 trillion, which is trivial compared to the BoJ’s balance sheet of around ¥400 trillion. Moreover, the BoJ already owns over 50% of the equity market ETF, making it a top 10 shareholder in 90% of Nikkei stocks. As for corporate bonds, this asset class barely exists in Japan. Japanese companies are flush with cash (which is the source of Japan’s large current account surplus) or tend to borrow from the banks.

Finally, the fiasco following the introduction of negative interest rates in January must have put the BoJ off on going further down that path today.

The Japanese yen soared and stocks tanked overnight on the lack of new measures by the BoJ. This is not surprising as Japanese equities have essentially been a BoJ/currency call. As investors come to realize that it will be difficult for the BoJ to ease policy further, the risks are tilted to further yen strength. A dovish Fed will only accentuate the downtrend in USD/JPY.