December 18th, 2015 6:40 am | by John Jansen |

Via Marc Chandler at Brown Brothers Harriman:

Dollar Mixed; BOJ Roils Markets

– The Bank of Japan made five adjustments to Japan’s unorthodox monetary policy; however, the expansion of the BOJ’s balance sheet remains unchanged at JPY80 trillion a year

– The onset of the holiday market conditions, especially following the FOMC meeting, is an important factor that obscures whatever signal is being generated

– It turned out that the first day after the rate hike was fairly smooth; the first Fed official will speak today since the decision to hike rate  

– Mexico and Chile hiked 25 bp yesterday; Brazil may have to restart rate hikes in 2016; Colombia is expected to hike 25 bp today

Price action:  The dollar is mixed against the majors.  The yen is the best performer, up 1% after initially selling after the BOJ announcement.  The Norwegian krone and the Loonie are underperforming.  The euro is trading near $1.0820 after being unable to break below $1.08, while sterling is trading back above $1.49 after being unable to break below yesterday’s low near $1.4865.  Dollar/yen is trading near 121.30 after earlier trading above 123.50, as markets had trouble digesting the BOJ tweaks to QE.  EM currencies are mixed too.  ZAR, IDR, and MYR are outperforming while BRL, KRW, and THB are underperforming.  BRL is being hurt by poor data and negative political developments.  MSCI Asia Pacific was down 0.6% on the day, with the Nikkei down 1.9%.  MSCI EM is down nearly 1%, breaking a streak of three straight up days.  The Shanghai Composite was flat while the Shenzen Composite was down 0.3%.  Euro Stoxx 600 is down 0.2% near midday, while US futures are pointing to a lower open.  The 10-year UST yield is down 1 bp at 2.21%, while European bond markets are mostly firmer.  Commodity prices are mixed, with oil down 1-1.5% and copper up nearly 1%.  

  • The Bank of Japan was the fourth major central bank to meet this week.  Sweden and Norway kept policy unchanged.  The Fed hiked.  The BOJ was not expected to do anything.  Governor Kuroda surprised the market with largely operational tweaks to what Japan calls Qualitative and Quantitative Easing.  Initially, and perhaps with the help of headline reading algos, the yen sold off and Japanese shares rallied.  As cooler, or perhaps human, heads prevailed, the markets reversed.  
  • There are five adjustments to Japan’s unorthodox monetary policy.  However, it should be noted upfront that the expansion of the BOJ’s balance sheet remains unchanged at JPY80 trillion a year.  

1.  JGBs–the BOJ will lengthen the maturities it buys from 10 to 12 years.

2.  REITs–the prior cap, limiting BOJ ownership to 5% of any issue has been raised to 10%.

3.  Loans–There were two corporate loan programs that pre-dated Kuroda’s appointment.  These were extended.  

4.  Collateral–the BOJ will now accept foreign currency denominated loans and housing loans as collateral.  BOJ buying of JGBs removes instruments that Japanese banks use as collateral.

5.  ETS–This is the most complicated of the measures announced.  In addition to the JPY3 trillion of ETF purchases, the BOJ appeared to offer a new JPY300 bln buying program.  However, this is offset in full by a BOJ equity selling program that is to begin at the start of the new fiscal year in April to facilitate the bank unwinding cross shareholdings.  The BOJ will begin selling the shares it acquired through this start in April.  It anticipates selling about JPY300 bln a year.  It did extend by 4.5 years (to March 2026) this program.  

  • We think there is validity in Kuroda’s argument that the measures announced do not amount to additional easing.  He argued these measures were operationally necessary.  Three board members objected.  The markets seem confused and whipsawed.  The Nikkei initially jumped 3%, reversed, and closed on its lows, which were about 2% below the previous day’s close.  The reversal saw the Nikkei close the downside gap created by Thursday’s sharply higher opening.    
  • The dollar’s movement against the yen was similar, though of a smaller magnitude than equities.  The dollar initially jumped from about JPY122.50 to JPY123.55 and then reversed, hitting JPY121.00 in the European morning.  The exaggerated price action is partly a function of the surprise, but also a function of liquidity.  We look for the dollar to return to the status quo ante–by which we mean where it was prior to the BOJ’s announcement, or roughly JPY122.50.
  • The onset of the holiday market conditions, especially following the FOMC meeting, is an important factor that obscures whatever signal is being generated.  Moreover, even though the Fed hiked rates on Wednesday, all the subsequent price action cannot be fairly attributed to the Federal Reserve.  Countless stories in the press, for example, attribute the decline in oil prices to the Fed’s hike.  There was little recognition in such press accounts that US was moving to lift the ban on oil exports or that sanctions against Iran were to be lifted following the end of the investigation into its nuclear development.      
  • It turned out that the first day after the rate hike was fairly smooth.  The yield on Fed funds was quickly marked up.  The Fed conducted a reverse repo operation for $105 bln, which was about $3 bln more than the operation on Wednesday, and well below some of the numbers that were being thrown around before the hike.  The yield on general collateral (GC) for repos was 0.414% and with the rate until the end of the year around 0.45%, the stability is expected to persist.    
  • Ahead of the weekend there are three events left that will attract attention.  First, Canada reports November CPI.  The headline rate is expected to rise to 1.5% from 1.0%, largely on the base effect.  Core CPI, which if flat on the month, will still see the year-over-year rate rise to 2.3% from 2.1%.    Canada’s problem is not prices, but growth.  Canada’s economy contracted from January through May.  It expanded from June through August, but then contracted in September.  That contraction in September offset nearly half the growth reported in the previous three months.  While the Bank of Canada is in no hurry to ease again, market expectations for another cut appears to be growing.  
  • The second event is that the first Fed official will speak since the decision to hike rate.  Richmond Fed President Lacker presents his 2016 economic outlook around 1:00 pm ET.  Even though there were no dissents in the Fed’s decision to raise rates, Lacker is seen as being on the hawkish side of the Fed’s spectrum.
  • The third even is the large option expires at the NY cut.  DTCC reports more than 5 bln euros at $1.08 and $1.09 expire today.  Dollar options struck at JPY121.5 are a little more than $1 bln and $3 bln at JPY122.  There are $600 mln sterling options struck at $1.49 and $430 mln struck at $1.4850.  
  • Banco de Mexico hiked rates 25 bp to 3.25% yesterday, as expected.  This was the first hike since 2008, and the bank said that the move was in response to the Fed, adding that it was playing close attention to possible inflation pass-through from the weak peso.  We think this rate hike was a questionable move, as inflation is at all-time lows and the economy appears to be slowing a bit.  The peso firmed after the hike, but then softened into the close.   Lower oil prices remain a headwind for the economy.
  • Chile also hiked 25 bp to 3.5% yesterday, but the market was split.  Of the 26 analysts polled by Bloomberg, 14 saw no change and 12 saw a 25 bp hike to 3.5%.  This was the second hike in the cycle, with the first one seen back in October.  However, inflation has already moved back into the 2-4% target range and so we think another rate hike is unlikely several months now.  The economy has been getting some limited traction recently, but the continued slide in copper prices will weigh on growth.
  • Brazil reported mid-December IPCA inflation at 10.71% y/y vs. 10.65% consensus.  This is the highest since November 2003.  Brazil also reported the October monthly GDP proxy, which came in weaker than expected at -6.4% y/y.  The economy remains in recession, but rising price pressures could push COPOM into resuming the tightening cycle next year.
  • Elsewhere in Brazil, local press is reporting that Finance Minister Levy may step down today, with Planning Minister Barbosa said to be a potential replacement.  This would be a bad development.  The Supreme Court ruled that impeachment proceedings can move forward, but agreed to new procedures that seem to benefit Rousseff and improve her chances of survival.  To us, the whole impeachment process is negative for Brazil by being a distraction that will delay fiscal adjustments      
  • Colombia central bank meets and is expected to hike rates 25 bp to 5.75%.  Of the 37 analysts polled by Bloomberg, 3 see no change, 32 see a 25 bp hike to 5.75%, and 2 see a 50 bp hike to 6.0%.  With USD/COP making new all-time highs and inflation still rising, we think there is a slight chance of a hawkish surprise of 50 bp today.
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