FOMC pull trigger and launch balance sheet reduction programme
As widely expected, the FOMC finally triggered the process to reduce the size of its $4.5tn balance sheet. Although the normalization process will start in October, which could be seen as a bit rushed, the pace of disinvestment will be very slow and has already been well telegraphed as described in the Addendum to the Policy Normalization Principles and Plans released in June.
Unsurprisingly, the US dollar reacted in a volatile fashion amid the announcement as investors struggled to assess the short and medium-term consequences of this decision. High quality commodity currencies such as the CAD, NZD and AUD experienced a more acute sell-off, mostly due to the substantial proportion of long speculative position in those currencies against the USD. The single currency dropped more than 1% but quickly stabilized slightly below 1.19, while the pound sterling slid only 0.70% to $1.35.
It must be noted that all in all, it wasn’t a hawkish meeting with both the statement and Yellen’s speech being cautious. The Fed revised downwardly its inflation forecast. Now, FOMC members don’t expect core inflation to reach the 2% percent until 2019. However, the growth forecast was moderately revised to the upside as the real GDP growth forecast has been lifted to 2.4% for 2017 compared to 2.2% previously. Finally, Fed officials cut the forecast for the official rate down to 2.8% in the long-term from 3%, suggesting a stabilisation of the economy.
Bank of Japan still on the accommodative side.
During the night, the Bank of Japan has announced its rate remain on hold. It is certain that the Bank of Japan was also closely looking towards the Fed which had its meeting yesterday night. The US central bank has announced a reduction of its balance sheet which is providing some relief to the USDJPY. Indeed, the currency pair has surged above 112.
Markets will now start pricing the end of the Quantitative Easing. The big unknown is how will react the global bond markets as higher yields would likely trigger a sell-off which can be massive as free money kept flowing into this market during the last decade.
The BoJ is going to continue its all-in monetary policy by buying assets at around Yen 80 trillion a year. This can definitely not end well. Some BoJ members believe that the inflation target of 2% is too high for the current monetary policy which is, in definite, not loose enough. For the time being, the BoJ maintains its 10-year government bond target around 0 percent.
Against the backdrop of the US balance sheet reduction, we consider that the USDJPY is set to appreciate towards 114 within the short-term.
