Market Strategist
Summary: While markets are digesting higher-for-longer, Bank of Japan maintained its lower-for-longer policy and Governor Ueda provided little follow-through on his earlier remarks of an earlier exit from negative interest rates. Surprise pauses from Bank of England and Swiss National Bank could however bring room to stay higher-for-longer, although GBP still faces risks from potential for dovish repricing. Meanwhile, SEK strength on FX hedging may remain temporary.
The Bank of Japan left its monetary settings unchanged today, including the negative interest rate and the range around its 10-year yield target. Governor Ueda’s press conference also lacked any hawkish tilts whatsoever, and these dampened expectations of an earlier move away from negative interest rate policy as was hinted in comments earlier this month. Ueda said that “distance to removing negative rates hasn’t moved greatly”, clarifying his earlier comments.
While a greater degree of FX comments were seen in the weeks leading upto the meeting, and comment from US Treasury Secretary Yellen also seemed to give room for more direct comments on yen weakness. However, inflation and wages remained the bigger focus and still seem to be the catalyst to drive any policy normalization from the BOJ. Ueda noted “extremely high uncertainty” over wages right now, although he stayed away from giving a timeline on when he would have a better understanding of next year’s wage trends, again staying away from his earlier comment that he should have that information by year end. Still, he did say that July inflation did not decelerate as expected, and good corporate earnings bode well for wage hikes next year. This suggests the case for a policy change can still be made, but the timeline remains extended.
The Bank of England voted to keep rates unchanged yesterday in a surprise decision with a very close vote split of 5-4. We had noted going into this week that markets are under-pricing the risk of a pause, especially because both of the two key pain point for the central bank – services inflation and private sector wages – had started to show some relief. Meanwhile, commentary from BOE officials had also tilted dovish with the UK consumers losing confidence in the central bank due to the cost-of-living crisis.
However, even as rates held at 5.25%, the BOE left all options on the table and attempted to send out a hawkish vibe. The Bank upscaled the rate of quantitative tightening from £80b to £100b per annum to accommodate a larger bond maturity profile next year. A tightening bias was also maintained in the statement with the MPC repeating the message that “further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures”.
However, growth outlook appeared more dire with third quarter GDP expected to “rise only slightly” vs. 0.4% growth predicted in August and risk of a recession in the winter is evident. In fact, ahead of today’s release, BOE hinted that it looked at the PMIs which sets a bearish tone as the release comes out today. Market still expects another rate hike with 70% probability, but the big question is what can bring that. Perhaps a big turnaround in services inflation or wage pressures should remain at the core of that expectation, but the central bank image could get hurt if data trends diverge again from their thinking so quickly. Focus is likely to remain on higher-for-longer, rather than taking interest rates any higher from here unless conditions change materially.
In terms of who cuts rates first among the major central banks, market is pricing the first full rate cut from the Fed and ECB in July, but from the BOE only in late 2024. This suggests that risks of dovish repricing remain the highest for the GBP.
Among other major central banks yesterday, the Swiss National Bank paused in a surprise move while Riksbank and Norges Bank announced 25bps rate hikes.
For the Riksbank, inflation and weakness in SEK still remain key concerns. As the hike was expected, it had an initial negative impact on SEK which was somewhat offset later by the announcement on FX reserve hedging to start in September. Riksbank announced it will sell USD 8bn and EUR 2bn for its forex reserves in the next four to six months. This is a preemptive move with the aim of limiting the losses if the krona appreciates. It was reiterated that it does not have a monetary policy purpose, although some see it as an FX intervention. EURSEK stays near recent highs at 12.00 and may remain exposed to any dovish data releases that reduce the probability of another rate hike.
Meanwhile, CHF weakened on Swiss National Bank’s surprise pause, but recovery remains likely, especially on the cross EURCHF, as a hawkish bias is easier to maintain when interest rates stay on hold. More importantly, the SNB continues to pursue a policy of keeping real exchange rate stable and would likely continue to sell FX to boost CHF. A strong dollar environment would potentially give greater room for the CHF to appreciate on the crosses. Swiss franc is also a key hedge for recession.
Bond. Long Bond(s)
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