Monetary Policymakers’ Busy Week Yields Little of Note

For people with such a busy calendar, it seems to us the world’s monetary policymakers did a whole lot of nothing this week. The US Federal Reserve (Fed) continued its rate pause.^[i] So did the Bank of England (BoE).^[ii] And Norway’s Norges Bank.^[iii] In our view, the only action of note—if you wish to call it that—came from the Bank of Japan (BoJ), which refrained from hiking rates but did tweak its “yield curve control” (YCC) program of capping 10-year Japanese Government Bond (JGB) yields.^[iv] Unsurprisingly to us, with scant action to analyse, publications we follow turned their attention to the words accompanying all the announcements—particularly in the US and UK. We happen to find the BoJ’s move much more interesting, but we doubt any of it means much for stocks.

In the US, commentators we follow made rather a big to-do of a slight tweak to the Fed’s policy statement. Where September’s statement described the economic growth rate as a “solid pace,” November’s statement opted for “strong pace.”^[v] Several outlets we follow chose to interpret this as an upgrade, which we find, well, a bit weird? For one, last week’s gross domestic product (GDP, a government-produced measure of economic output) report confirmed growth accelerated in Q3, which might match some peoples’ interpretation of the Fed’s edits, but that news seemed to make commentators we follow pretty curmudgeonly.^[vi] Commentators we follow who didn’t see it as overheating warned it would be a short-lived sugar high, giving way to a wintertime hangover. Sooo … faster growth is bad when it shows in the data but good when the Fed looks it in the face?

Then, too, we won’t know for five years whether the Fed committee members actually intended to raise their economic assessment this month, as the Fed releases meeting transcripts at a five-year delay. We searched the Fed’s publication archives and did not find a style guide that arranges all possible adjectives for the economy in order from worst/weakest to best/strongest. So there is no way to know, officially, whether “strong” outranks “solid,” and what the range of official adjectives actually is. In our experience, many people use those words interchangeably in everyday life. And depending on the emphasis/tone, solid could actually be, um, stronger than strong. We just don’t know! But we suspect the transcripts of this meeting, when available in 2028, will show a debate on par with the FOMC’s past haggling over a single adverb. We don’t recommend reading into it.

We wouldn’t read into the BoE’s widely covered 2024 forecast, either. The BoE has garnered a lot of attention amongst publications we follow over the past year-plus for revising its projections as it seemingly chased the latest results. Last year it kept pushing out the start date of its anticipated recession (a period of contracting economic output) as growth stayed resilient.^[vii] Eventually it wiped recession out of the forecast entirely, conceding output would grow this year.^[viii] So far, that has held true.^[ix] But now the BoE again sees tough times ahead. Where initially it projected 0.5% growth in 2024, it now pencils in flat GDP for the full year with a 50/50 chance of a recession at some point.^[x]

We find it tempting to dismiss this ad hominem with a their prior recession forecast was wrong so why would this one be right. But that is a logical fallacy, in our view, so we will instead make a couple of points. One, like the prior forecast revisions, this one follows data. Better-than-expected growth preceded last year’s upward revisions, and now some wobbling purchasing managers’ indexes and occasionally contracting monthly GDP seem to be informing the downgrade.^[xi] The BoE isn’t alone in this approach—monetary policy institutions globally seem much better at summarising what just happened than actually predicting what comes next. Two, the BoE seems to be presuming its 14 straight rate hikes will conquer inflation (broadly rising prices across the economy) and hurt the economy as an unfortunate side effect.^[xii] This is standard monetary policy thinking, in our experience, but we think it is too simplistic. Maybe rate hikes do come home to roost as lending continues falling, and maybe that does pinch output.^[xiii] But the small recent drops in lending and broad money supply come off a very high base—one we think was inflated by BoE-generated, largely inexplicable (in our view) pandemic-era distortions—so we think some wait-and-see is in order.^[xiv] We think it could well be that we are simply seeing some so-called zombie companies, kept afloat artificially by cheap COVID-era support, finally roll off the books as market forces return and failing firms finally go under. Whilst this is bad news for those directly affected, we don’t think it is a negative leading economic indicator, and we find it tends to free up capital for more productive use. And our research suggests that markets tend to suss all that out long before filings hit.

As for the BoJ, its change was mostly semantic, in our view. Before this week, YCC involved pegging 10-year JGB yields to 0% plus or minus half a percentage point. What this meant, in practice, was that the BoJ would buy bonds on the open market to get yields to fall to where it wanted them (or vice versa). There is a vast ocean of scholarly research showing pegs like this are inherently unstable, as markets eventually test the bank’s resolve, and markets tested the BoJ throughout the summer and early autumn, pushing 10-year yields well past 0.5% and close to 1.0%.^[xv] Along the way, the BoJ said it would purchase JGBs at yields at as high at 1.0%, but it wasn’t an official YCC change.^[xvi] This week, the BoJ went one step further, saying it would use 1.0% as a “reference rate” when buying bonds on the open market, giving it wiggle room to buy at higher yields if policymakers deemed necessary.^[xvii]

Publications we follow heralded this as a big change, and we agree … to a point. By dropping a firm target, we think the BoJ is giving market forces the most influence they have had over Japan’s long rates in over a decade. In our view, that is noteworthy and a step toward policy normalisation. But only a small one. The BoJ hasn’t stopped buying bonds. It isn’t unwinding its balance sheet. And it retains the right to intervene. So in our view, it is a long way behind the Fed, BoE and European Central Bank on the normalisation front. And, again, we think monetary policy institutions taught everyone watching that you can’t take their words to the bank just last year. This could be another layer to the lesson.

In terms of the practical effect, however, we think it mostly extends the status quo. 10-year yields had already crept very close to 1.0%, which the BoJ seemed to be allowing in the name of putting a floor under the yen.^[xviii] Thing is, for months now, commentators we follow have argued higher long-term JGB yields would strengthen the yen as bigger payouts enticed more overseas money. Yet the yen remains near 30-year lows relative to the dollar.^[xix] Higher JGB yields didn’t strengthen the yen or weaken the greenback.^[xx] Money still flowed to the highest-yielding asset, as our research shows it typically does.

So we doubt the BoJ’s latest move means much for Japanese stocks. The weak yen creates winners and losers. Our research finds the beneficiaries tend to be the big Japanese multinationals that can reap big profits from currency translation. We think companies more focused on Japanese demand tend to face more headwinds. But in our view, this divergence has been a major theme of Japanese stocks for years now.