All eyes were watching yesterday as the Bank of Japan (BOJ) and the U.S. Federal Open Market Committee (FOMC) announced their current decisions regarding monetary policy. There has been increasing doubt regarding the true effectiveness of recent approaches, particularly open market bond purchases (so called “quantitative easing”), in terms of improving economic growth and spurring inflation. In an apparent acknowledgement of that, the BOJ announced that it would change its policy approach and focus on interest rates and the yield curve rather than the money supply. BOJ Governor Kuroda characterized the change as an enhancement to current policy but this can be seen as a significant shift and an acknowledgement that the recent policy of aggressive easing has not produced sustainable economic results. Japanese bank stocks rallied on the news and the yield on 10 year Japanese Government Bonds (JGBs) turned positive. The BOJ remains focused on achieving its 2 percent inflation target.
To little surprise (but frustration in some circles), the FOMC held steady on rates. The Federal Reserve is data dependent and had a weakening case for a rate hike based on recent metrics including retail sales and industrial production data. But, the Fed’s forward guidance indicated its belief that the case for an interest rate increase has strengthened based on indicators including household spending, consumer sentiment and labor market trends. Fed watchers believe that the central bank is setting the table for one hike in 2016, most likely in December.
As the market mantra says, “You can’t fight the Fed”. We will continue to pay attention to central bank policy in the US as well as Japan, Europe and the UK in recognition that, beyond the economic impact, policy moves markets. As market participants, we believe the time for this type of market manipulation has long passed, both from an investment perspective as well as in recognition that the economic benefits are fleeting. Ultimately, we are believers in the fundamental drivers of markets (e.g., earnings growth, valuation). These policies continue to overwhelm the fundamentals (is “risk on/risk off” the new paradigm?) and force active investment managers to disproportionately account for and weight top-down policy in an otherwise bottom-up process. It is time for the central bankers to step back and allow the markets to function on their own.