Three Suprises before BOE and ECB

There have been three surprises for the market to digest and this is ahead of the Bank of England and European Central Bank Meetings. The biggest surprise is the BOJ, which triggered a dramatic reversal in the yen and Japanese stocks and bonds. Australia began the day by surprising the market with strong retail sales and building approval data, though the real surprise may be failure of the Australian dollar to hold on even modest upticks and fell to 3-day lows just above $1.04. The third surprise was the European service PMIs. The disappointment came from Germany and, especially France, while the UK, Italy and Spain surprised on the upside.

The Bank of Japan came through and after elevating market expectations, still managed to provide upside surprises. In particular, the switch in policy targets from the overnight call money to the monetary base (cash plus bank deposits) was perhaps the most important qualitative surprise. The BOJ intends to double the monetary base over the next two years. It was about JPY138 trillion at the end of last year. 

The BOJ intends to buy sufficient assets to pump this up to JPY200 trillion by the end of this year and JPY270 trillion by the end of next year. To achieve this, which itself is a means, it thinks, to lifting CPI to 2%, the BOJ will buy more JGBs with longer maturities, and making even the 40 year JGB eligible. BOJ Governor Kuroda had also indicated a desire to increase the purchases of riskier assets as well and to this end, increased ETF and REIT purchases.

The Nikkei, which had been off around 2% before the announcement, stormed back to finish up 2.2% and to move within spitting distance of the 12650 cyclical high set on March 21. Financials led the way, gaining 5.25%. Japanese government bond yields fell sharply and the long-end of the yield curve flattened with the yield on the 30-year dropping twice as much as the 11 bp decline in 10-year. The dollar was trading below JPY93 before the BOJ's announcement; it quickly rallied to almost JPY95.70 before consolidating in the European morning. 

We too had that the risks lie with disappointment. We remain skeptical that a return to targeting the monetary base, which was the case until 2006, will succeed. The monetary base stood at a record at the end of March. The problem is that monetary base is not spilling over into the real economy. This is what is meant by pushing on the string.   Timing is important and the market, like us, had been leaning the other way today and position adjusting may have more room to run in the near-term. 

Australia data was much better than expected and provided further fodder for arguments that the RBA's easing cycle is over at 175 bp.  February retail sales jumped 1.3%, rather than the 0.3% the consensus expected and the robust 0.9% rise in January was revised to 1.3%.   Separately, Australia reported building approvals rose 3.1% in Feb, which was also better than the 2.5% expected and the January series was revised to show a smaller decline (-2% rather than -2.4%). 

The Australian dollar initially rallied, but was unable to rise above yesterday's high just shy of $1.05 and returned to almost $1.04.     A potential double top is in place near $1.05.  A break of the neck line, seen at Monday's low near $.10385 needs to be taken to confirm the pattern.  It would project toward $1.03, which also corresponds to a 50% retracement of the rally from the early March low set net $1.0115.  

The third surprise today is the release of the service sector PMIs in Europe.  The EMU reading slipped to 46.4 from the 46.5 flash reading, and down from the 47.9 in February.  Downward revisions to Germany (50.9 from 51.6 flash and 54.7 in February) and France (41.3 from 41.9 flash and 43.7 in February) were the main culprits.  Spain and Italy extended their streak below the 50-boomo/bust level for 21 and 22 months respectively, but showed modest improvement from February).   The euro was sold on the news, but has held above Monday's low set near $1.2770 and above the $1.2750 seen last week.   

Separately, the UK reported better than expected service PMI.  The 52.4 reading is the strongest since last May.  The consensus expected some weakness to 51.5 from 51.8 in February.  The service sector accounts for a full three quarters of the UK economy.  The strength of today's report likely means that UK economy expanded slightly in Q1.  Sterling was not helped by the data and actually fared worse than the euro insofar as sterling fell to its lowest level since March 20, near $1.5035.