Kuroda Surprises, Introduces Negative Rates in Japan, Sinks Yen

The Bank of Japan surprised the market.  It did not expand its asset purchase plan, which was the main focus of many market participants, including ourselves.  Instead, following a rash of disappointing data, the BOJ introduced negative interest rates on some excess reserves and vowed to do more if necessary.  

Today's action, like the expected decision in October 2014 to increase what Japan calls Quantitative and Qualitative Easing was on a 5-4 vote.  It has sent the yen and Japanese interest rates sharply lower while lifting equity prices.  The dollar initially soared to nearly JPY121.50 from JPY118.50.  There are large option strikes today for the NY cut, including $1.75 bln at JPY120 and $3.5 bln at 121, according to reports.  There is also talk of a large barrier struck at JPY121.50.  The yield on the benchmark 10-year JGB was more than halved to 9 bp.  The yield curve is negative going out through eight years.  

In a volatile session, the Nikkei closed 2.8% higher.  It had initially traded below yesterday's lows and then rallied and closed above yesterday's highs.  It finished above its 20-day moving average for the first time since early December.  Financials were the strongest sector in the Nikkei, adding on almost 5.6%  though bank shares themselves fell 2.3%.  In the broader Topix index, financials underperformed. While the Topix rose 2.9%, financials rose 1.8%, and the bank sub-sector lost 2%.  

The negative rates will not be as widely applicable as the ECB's negative rate regime.  Most of existing excess reserves will still earn 10 bp annualized.  A sub-category of reserves referred to as the policy rate balance will be charged 10 bp.   Based on holdings as of the end of last year, the policy rates balance held JPY21 trillion.  As the BOJ continues to expand its balance sheet, the policy rate balance will likely increase by about JPY6 trillion a month. 

The BOJ cut its inflation forecast for the fiscal year that begins April 1 to 0.8% from 1.4%.  It also pushed out by six months to the start of FY2017 when it will reach its 2% inflation target.  Before the BOJ's announcement, the December core (excluding fresh food) rate was reported unchanged at 0.1%.  The measure that the BOJ has heralded, though not officially targeted, excludes energy as well, rose 1.3% year-over-year.  In November, it was 1.2% higher.  

The news from Japan dominates the markets today.  It has helped lift global equities and bonds.  It underscores the divergence meme which anchors our bullish dollar outlook.  Selling the yen on the crosses is a factor today influencing some of the price action.  In addition, as we have noted, the speculative community, judging from the futures market, had built a net long yen position for the first time in several years.  The BOJ once again surprised the market, and part of the yen's weakness likely reflects the liquidation of these longs. 

Another important development this week that is continuing today is the recovery in oil prices.  The ostensible drivers is speculation that the low price may be finally forcing discussion of output cuts.  The focus is on Russia, following Novak, the energy minister, indication that Russia is ready to meet with OPEC to discuss cuts.  Venezuela and Algeria have been pushing for a 5% cut in output, which would remove almost two mln barrels a day from production. 

We share three observations.  First, news reports have Saudi officials denying that a meeting has been called.  They also say that it has not proposed a 5% cut.  Second, a Lukoil executive conditioned his willingness to cut output on "political backing from Moscow."  Third, the views of a key player in this, Sechin, the head of Rosneft, said to be a close Putin ally, does not seem to have been included in media coverage.  Previously, Sechin had argued that the harsh winter and the numerous private Russian energy companies made it impossible to orchestrate a cut in output.  

We are concerned that with Iranian oil output increasing, the bloc led by Saudi Arabia will be loath to cut output.  It would be surrendering market share to a significant regional rival.  That said, if OPEC and Russia do agree on a cut in output, we suspect the US producers will be significant beneficiaries.  US producers would enjoy a bit of a free-ride.   

News in Europe has been overshadowed by the Japanese developments.  However, a few economic reports should not go unnoticed.  First, the preliminary CPI reading for the eurozone was reported in line with expectation.  In January, consumer prices rose 0.4% from a year ago.  This was in line with expectations.  This is up from 0.2% in December.  The core rate rose to 1.0% from 0.9%.  Bundesbank's Weidmann, critical of the ECB's course, acknowledged that headline CPI may fall back into negative territory in the coming months.  However, he argued that policymakers should look through the decline in oil prices, and cited the rising core rate.  

Separately, the ECB reported that money supply growth slowed in December to a 4.7% pace from 5.0% (initially 5.1%).  The market had expected an acceleration.  The ECB was likely disappointed to learn that lending to nonfinancial businesses slowed to 0.3% from 0.7% in November.  Loans to households was unchanged at 1.4%.   On balance, we do not think that today's data will deter Draghi from pressing for more action at the March ECB meeting.  

While France and Spain reported Q4 GDP figures today (both in line with expectations at 0.2% and 0.8% respectively), the focus turns to US GDP figures.  Yesterday's poor durable goods report for December weighs on expectations.  We suspect there is downside risk surveys conducted earlier that showed a consensus of 0.8%, although the Atlanta Fed GDPNow says it is tracking 1.0%.   

The FOMC statement acknowledged that growth has slowed at the end of last year.   We do not think today's GDP report will impact the forward-looking central bank.  How the economy does now is more important than what happened in Q4 from a policy-making perspective.  US economy is expected to growth 1.5%-2.0% at an annualized pace Q1 16.

The US also reports Q4 Employment Cost Index (expected to rise 0.6% the same as in Q3), and the December advanced merchandise trade balance (expected at $60 bln deficit, little changed from November).  However, with Q4 behind us, the data for Q1 is more important.  Here the January Chicago PMI may attract attention.  It stood at a lowly 42.9 in December.  It is expected to rebound toward 45.3.  We have noted the divergence between the US manufacturing and service sectors in H2 15, and there is no reason not to expect it to carry into the new year. 

The University of Michigan’s final January consumer confidence reading will be released.  The important element here may not be the confidence but the inflation expectations.  The FOMC statement cited both the market-based measures (softened) and survey-based measures (stabilized).  The preliminary confidence report included a small rise to 2.7% from 2.6% for the inflation expectation for 5-10 years.  It had bottomed in October at 2.5%.  

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