Ameriprise Financial : The Reaction to Central Bank Inaction

The influence of central banks continues to exert itself, even when they do nothing. Last week the Federal Reserve stood pat, leaving its options open regarding the pace and timing of future rate increases. And although its decision statement was dissected ad infinitum, the effect on markets was negligible. It wasn't until the day following the Fed meeting, when the Bank of Japan also chose to stand pat, that markets began to react. Whereas the Fed's inaction was widely anticipated, it was also widely assumed that the BOJ would not only act, but do so boldly in the face of slow growth, a rising currency, and falling prices. Currency markets responded immediately, pushing the yen higher and the dollar lower. By week's end the yen was trading at 106 to the dollar, down from 108 at midweek. Since adopting negative interest rates in late January, the yen has surged from 121 to the dollar, creating an unanticipated headwind for exporters, and confounding policy makers. It likely won't be long before the BOJ does initiate further easing, perhaps choosing to wait for the late May G-7 meeting it is hosting. But how effective even lower negative rates will be remains in doubt. Europe has been living with negative rates for a while, as far back as mid-2014, with little evidence of a positive effect. In fact, some argue that the effect is perversely negative, as worried consumers respond by saving more and spending less.
Good news in Europe It was the European Central Bank which was the recipient of good news last week. First quarter growth throughout the Eurozone exceeded expectations, climbing by 0.6 percent sequentially and 1.6 percent year-over-year, with help from unexpected strength in France. The quarter was the strongest since the same period last year, while the year-over-year growth rate matched that of the previous quarter. Headline inflation remained negative, however, and the core rate edged down to 0.7 from 1.0 percent. Nevertheless, the euro firmed, and was trading above 1.15 versus the dollar on Monday. As with the BOJ, currency strength is making the ECB's job more difficult. But as long as the Fed maintains a relatively dovish stance the dollar's recent weakness is likely to persist, and that is good news for U.S. exporters, commodity producers, and China.
Busy Economic Calendar Ahead The Fed is back to being data dependent, and the domestic economic calendar this week is loaded. Friday's jobs report tops the list and is expected to show the creation of 200K new jobs and a decline in the unemployment rate to 4.9 percent. Average hourly earnings are expected to rise to 2.4 percent year-over-year, but still below a level that would raise concerns for building inflationary pressure. On Monday, the ISM manufacturing report for April showed another month of expansion. And although the pace was slower, growth was more broad based across a wider group of industries. Later in the week we get readings on vehicle sales, and strength in the service sector. Stocks struggled last week against a backdrop of mixed earnings reports, and soft economic data. The S&P 500 fell 1.3 percent, while the Nasdaq shed 2.7 percent. Bond yields slipped as well. But a weaker dollar, should it persist, makes it far more likely that the economy and earnings will improve as the year progresses. The Fed would certainly help that along by remaining on the sidelines, as long as evidence of rising inflation does not force its hand. But Tips breakeven rates have risen. And if the price of oil stays where it is, by Labor Day the year-over-year downward pull on headline inflation will be ending. Data dependent indeed.
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