Leaders of the Bank of Japan (BoJ) and the Federal Reserve, separately, discussed their interest rate policies in the last couple of days. While the benchmark interest rates of these central banks have been kept on hold for now, we would like to highlight some elements that may be attention-worthy.
BoJ – Tweaking Its Strategy
The BoJ announced on Wednesday that it would be introducing “Quantitative and Qualitative Monetary Easing Yield Curve Control.” Under this framework, instead of the traditional way of directing the cost and availability of liquidity to the market through adjusting the monetary base, the BoJ will from now on exert its influence by controlling the short- and long-term interest rates (Chart 1). By design, it means that the BoJ will manage the interest rates by adjusting its portfolio of Japanese Government Bonds (JGB) purchases. While it was discussed in the monetary policy meeting on 15-16 June that the “average remaining maturity of the Bank's JGB purchases would be about 7-12 years,”[1] the recent communiqué has removed such guidelines on the duration of JGB purchases. Such changes could imply the purchases would focus on those with maturities under 10 years.
Nevertheless, details of the execution of such a policy shift were rather vague, possibly due to a lack of consensus among board members (i.e. 7-2 votes) and the presence of many variables. Among the unknowns, for instance, the communiqué did not reveal if and how much of a deviation of the 10-year bond yield from the targeted-0% would be allowed, which would have implications on the scale of annual purchases that is currently set at 80 trillion yen a year.
Federal Open Market Committee (FOMC) Not Rocking the Boat
In the U.S., the FOMC has also decided to keep the interest rates on hold for the sixth time since bringing it up by a notch in December 2015. In its statement, similar to the previous post-meeting communiqué, the FOMC maintained its stance on household spending and suggested that it “has been growing strongly” and business fixed investment has been “soft.”
While risks in the near term were described as “balanced,” it is noteworthy that members of the Fed have become less upbeat about the economy (see Table 1). The median real GDP growth projection for 4Q2016 has been lowered to 1.8% YoY, down 0.2 percentage points compared to the release in June. At the same time, the median expectation of the unemployment rate in 4Q2016 has been revised up by 0.1 percentage point compared to the June projection and reached 4.8%.
As a result of the above, the median expectation of the Fed funds rate has come down by 0.3 percentage points, suggesting that the FOMC participants currently expect interest rates to go up once – instead of the two rate hikes as indicated in June – before the end of the year, in line with our expectations.
Conclusion
In the case of the BoJ’s movement, such changes should not be considered as an expansion of monetary stimulus and may instead suggest that the central bank would like to, albeit subtly, control the overall leverage of the economy. According to the IMF’s World Economic Outlook database released in April, it is estimated that Japan’s gross government debt-to-GDP ratio would reach 249% by the end of this year. Indeed, the balance sheet of the central bank has expanded by 186% between the end of 2012 and August 2016 and should be contained (see Chart 2).
As for the U.S., given the 8 November presidential election, it is widely expected that the Fed would not make a move at the next meeting to be held on 1-2 November. However, as Fed Chairman Janet Yellen suggested that politics “emphatically” would not affect the Fed’s decision-making process, the possibility of a hike in November should not be ruled out, and this is particularly true if the employment market sees sustained signals of improvement (see Chart 3).
As for the implications on Hong Kong, we maintain the view that borrowing costs would remain stable in the near term, given the abundant liquidity in the banking system (see here).
[1] Bank of Japan (August 2016) Minutes of the Monetary Policy Meeting on June 15 and 16, 2016
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