The Bank of Japan surprised financial markets at their policy meeting on Friday by introducing negative interest rates on a portion of the reserves commercial banks hold at the BoJ. The bond market rallied, the yen weakened while equities took an incredible rollercoaster ride. Equities initially jumped some 4% within 15 minutes, only to drop some 5% during the next half hour, but recovered almost all these losses during the remainder of the day, finishing up 2.8% on the day. There may have been technicals at play here, but I think investors should ask themselves how to interpret further stimulus measures by central banks. It seems as though investors initially were euphoric, then depressed and in the end euphoric again.
Some people have started to talk about a recession in the US. That seems very unlikely to me, at least, any time soon.
Han de Jong Chief Economist
- The Japanese equity market did not seem to know what to make of the BoJ’s most recent twist: negative interest rates.
- Additional stimulus measures by central banks can be justified by a deterioration of the current situation and the outlook.
- The drop in eurozone economic confidence is unwelcome and future developments need to be monitored closely.
Do more measures underscore the uselessness of these measures?
Previously, non-conventional measures of monetary policy in various countries have generally provided support to investor confidence, reducing risk aversion or, if you prefer, boosting risk appetite. This may, or may not change as investors must ask themselves some pressing questions, particularly if the ECB were to step up its stimulus measures (which we expect) and if the US Federal Reserve does not deliver all the four rate hikes they have pencilled in for the year (which we expect). For example: why is it necessary for central banks to step up their non-conventional measures (or in the case of the Fed, tighten less than they were planning)? And, if all the measures that have been taken are not enough, why would taking more be positive? We are still in uncharted territory, so the answers to such questions are not necessarily evident. But let me try to provide some answers.
It has been difficult, if not impossible for central banks to know how big the non-conventional measures had to be. They have generally followed a shock-and-awe strategy, preferring to err on the side of ‘too much’ rather than ‘too little’. These sort of measures work through various channels. Clearly they work through asset markets, but they must also have a more direct impact on the real economy. And perhaps the impact on asset markets has been bigger than the direct effects on the real economy. Perhaps the deleveraging and deflationary forces in the real economy have been insufficiently overcome.
Another line of thought is that unconventional measures have allowed a process of deleveraging in developed economies without all the negative effects such processes bring for the real economy. The way it has worked is that against deleveraging in advanced economies, a process of building up debt took place in emerging economies. But now, this process is reversing. Following this line of thought, one could conclude that central banks in some countries should simply persist in their policies.
Meanwhile, economic data released last week saw Economic Confidence in the eurozone, the broad confidence measure produced by the European Commission, declining quite sharply in January, reaching 105.0, from 106.7.
This measure has been on an upward trajectory since late 2012 with a few short interruptions. What exactly is behind the January fall in the index is not clear. It may be that confidence is affected by the turmoil in financial markets. Another possibility is that eurozone businesses are starting to feel the negative impact of weakness in emerging economies and global trade. One observation certainly does not make a trend, but this is something that needs to be watched closely.
US data continues to paint a picture of an economy with two different faces. New home sales were strong in December, rising almost 11% on the month, and house prices are continuing their rise. The labour market also continues to be firm. Initial jobless claims fell to 278,000 in the latest week from 294,000. That is good news, but it does not yet break the upward trend in this indicator since October. The Chicago PMI was perhaps the most positive signal about the US economy. It rose to 55.6 in January, the highest reading since January last year. Consumer confidence also continues to be strong.
The weakest sector in the US economy clearly is the energy sector. Persistent low oil prices are demanding their toll from the industry. The Dallas Fed Manufacturing Activity measure fell sharply in January to its lowest level since 2009. The weakness in the energy sector is also affecting investment spending. The energy sector is capital intensive, so a sharp cut in investment spending has a noticeable impact on total investment spending for the whole economy. Durable goods orders fell sharply in December: -5.1% mom, which most likely was caused by a sharp drop in energy.
With some positive surprises and some negative ones, it is not surprising US GDP growth for Q4 was not far away from expectations. Of course, the headline number of +0.7% annualised is low and disappointing, but close to what was expected. The details of the report did not provide surprises. Inventories and net trade provided strong negatives for growth while investment in structures provided another, but smaller negative. The drag from inventories is, by definition a temporary thing.
Some people have started to talk about a recession in the US. That seems very unlikely to me, at least, any time soon. The fundamentals are simply too solid for the US economy to rollover into recession. Instead a gradual acceleration in the course of the year is more likely.