RBA & BOJ Rate Decisions Surprise Markets

Highlights
The US dollar rise yesterday looks like a one-day wonder, with the euro returning to the $1.38 area, sterling moving through yesterday’s highs and the Swiss franc at new record highs vs the greenback.  The Australian dollar is under-performing following the Reserve Bank of Australia’s decision not to hike rates as had been widely expected.  The Bank of Japan also surprised the market by adopting zero-interest rate policy and expanding its balance sheet launching a fund to buy JPY5 trillion of government and corporate paper.  This initially lifted the dollar initially about a half a yen to JPY84.00 before hitting offers thought to be leveraged accounts and Japanese exporters.   The doubling of Brazil’s tax on foreign purchases of bonds late yesterday will likely weigh on the Brazilian real, just as news that Korean officials will audit banks’ foreign exchange trading (Oct 19-Nov 5) undermined the Korean won, which has declined 0.7% today, the largest drop in six weeks. 

Asian stocks were mixed, with EMs being the hardest hit, after RBA and BoJ actions took the markets by surprise. In midday Europe the MSCI Asia Index was flat but positive, turning around some early session losses.  Japan’s Nikkei gained however, up 1.4% on the news that the BoJ cut lending rates from 0.1% to 0.0%.  Gains were, of course, led by financials and followed by consumer services, which were up over 2.3% by the afternoon session.  In Europe stocks rose as better-than-expected profit results suggested company earning may withstand the region’s debt crisis.  In fact, the Stoxx Europe 600 Index rose 0.5% the first advance in seven day, led by gains in consumer services and health care. 

In the midday European session most bonds climbed on the news that the BoJ will extend its asset purchases.  Japanese 10-year bond yields dropped as low as 0.895%, matching the lowest level in seven years, after the BOJ actions. Treasuries were on the front foot as comments from Fed chairman Bernanke last night gave encouragement to speculation that the Fed will also increase its bond-buying program. And in the EM space Turkish bonds gained, sending yields to their lowest level in a year after Moody’s Investors upgraded its outlook for the country. 

Currency Markets

Last night there were two important central bank announcements from the RBA and BOJ, both of which caught the markets by surprise.  The biggest surprise was provided by the RBA which was widely expected to hike rates by 25bps to 4.75% but remained on hold at 4.5%.  In fact two-thirds of the economists surveyed by Bloomberg were calling for a rate hike, along with a 65% chance derived from OIS derivatives.  Following the meeting the Reserve Bank of Australia Governor Glenn Stevens’s statement suggested that subdued credit growth and moderating inflation were the main reasons for the decision.  Although, the RBA added that higher borrowing costs will be needed at some point.  It appears that the decision to remain on hold was a combination of internal and external factors.  Domestically, for example, retail sales slowed in August to the weakest pace in six months.  Therefore, the inflation report on October 27 will be an important barometer to test the RBA willingness to hike.  Overall, the RBA remains hawkish and this short-term weakness may provide backdrop to enter fresh longs for medium-term strength. 

The BOJ surprised as well by easing policy.  Markets had, perhaps, expected an extension of the funds-supplying operations in size and probably maturity.  However, the BOJ made three significant changes in policy.  First, the target overnight call rate was set at 0 to 0.1%.  This, in fact, will allow the BoJ to provide extra liquidity and ease financial conditions. Second, the statement says that it will keep the policy rate around zero until price stability is in sight , strengthening the so-called policy duration effect. Finally, the BoJ announced the setting up of an asset purchase program worth JPY5trn over one year. The program will buy ¥3.5trn of long-term government bonds, ¥1trn of CP and ABCP and ¥0.5trn of ETFs, coupled with the already existing ¥30trn fixed-rate funds supplying operation brings the total to ¥35trn.  Again, this is an important step for easing monetary conditions but the impacts on the currency will be negligible if the Fed the increases its asset purchases to the current speculated amount of $500 – $1,000 bln. Therefore, any yen weakness will be short-lived as US yields continue to be the key driver. 

The euro zone and the UK service sector PMIs are better than expected.  The euro zone Sept reading stood at 54.1 vs the flash estimate of 53.6 in last Sept.  It is still down from the 55.6 level in August and represents a six-month low.  In terms of country highlights, Germany came in better than its flash (54.9 vs 54.6) and France came in a bit below (58.2 vs 58.8).  More worrisome is Spain’s continued erosion below 50 (47.9), for the third consecutive month.  Ireland’s reading also broke the 50 boom/bust level for the first time since March and the forward looking new business falling sharply (47.8 vs 53.9).  The UK surprised on the upside with a 52.8 reading compared to 51.3 in August.  Lastly, apart from the PMI reports, the euro zone reported an unexpected decline in August retail sales.  The consensus had called for a 0.2% increase after a0.1% gain in July.  Instead, August retail sales fell 0.4%.  The euro initially encountered follow through selling in Asia after the weak performance in Europe and North America on Monday.  After stops were triggered near $1.3650, good buying, which market talk linked to Asian central banks and hedge funds snapped the euro back.  It seemed to have run out of steam as the $1.3800 area was approached.  It is too early to talk of a double top, but a break back below $1.3750 could spur the talk. 

Moody’s placed Ireland on credit watch for a possible downgrade of its Aa2 rating, which is one notch above S&P and Fitch.  It should not be surprising, given the recent developments, including the steep Q2 contraction and the magnitude of the bank support efforts.  Moody’s also opined that Ireland does not require external aid.  This appears true for now.  Ireland has also indicated it will not go to the capital markets this month or next and it does not appear to have to go back until closer to the middle of 2011.  Irish bonds sold off on Moody’s credit-watch decision and with today’s 6 bp rise the 10-year bond has replaced Portugal’s bond as the worst performer in the euro zone over the past month.  Moody’s lifted Turkey’s Ba2 outlook to positive from stable and had unexpectedly nice things to say about Greece:  Greece’s efforts have been impressive and if they continue, Moody’s said, the risk to the sovereign rating is on the upside.  This is from the rating agency that had cut Greece to below investment grade less than four months ago, citing “ citing risks to its economic growth from the austerity measures. 

Upcoming Economic Releases

US ISM Non-Manufacturing Composite for the month of September is reported at 10:00 EST / 14:00 GMT.  Consensus is for a small increase to 52.0 from 51.5 in August.  ABC Consumer Confidence for the week of October 3 is reported at 17:00 EST / 21:00 GMT.  No consensus data but prior figure is in-line with quarterly average (45).  Bank of Canada Senior Dep. Gov. Macklem Speaks at 13:00 EST / 17:00 GMT.