Let the Central Banking Games Begin

It’s the first Tuesday of the month today. Perhaps more importantly, it’s the first Tuesday of the year that the Aussie central bankers will get together and make an interest rate decision.

Ah, let the central banking games for 2016 begin!

I’m a bit late though. They started last Friday.

That’s when the Japanese central bank met. And they were the first to blink this year.

The Bank of Japan (BoJ) decided that an economy inflicted with low inflation and almost zero gross domestic product (GDP) growth could do with negative interest rates. They lowered the cash rate from 0% to -0.1%.

Investors clearly didn’t know what to make of the move. The Nikkei rose on the news to begin with, then dropped, then closed up 2.3% higher the following day.

Have a look at the chart below to see what I mean.

Source: Google Finance

Overall, the index is up 5% since the announcement. But how long for? The euphoria of central bank intervention doesn’t seem to last very long these days.

In addition, the BoJ will continue with the quantitative easing program it started in 2014. Buying up to 80 trillion yen (AUD$930 billion) per year worth of government bonds and real estate trusts.

Basically, this move by the BoJ is the desperate attempt to get Japanese economy growing again.

You could say the central bank is penalising banks and other lenders for holding too much cash on deposit. And that it’s a desperate attempt to get consumers and business to borrow more and save less.

In fact, this move could be one giant gamble on the sentiment of the people. Negative interest rates could see people withdraw their cash from the banking system over time. Even if the cash rate is a negligible -0.1% and it doesn’t directly affect people. This move could signal a loss of faith in the banking system.

Aussie dollar rallies

Just as Japanese investors were wondering floorboards or mattress, the Aussie dollar decided to rally on the back of the central banks move.

Source: xe.com

The unconventional policy decision pushed the Aussie Dollar to a three week high.

Which, for the Reserve Bank of Australia, isn’t the news they’re after. Although it’s highly unlikely that the RBA will cut rates this afternoon.

The word on the street — for those that like eavesdropping on central bankers — is that the RBA is going for a more ‘dovish’ sort of policy.

If that’s the case, we pretty much know the direction of the RBA’s decisions for the year. When you hear the term from ‘dovish’ from central bankers, it tells you they are leaning towards cutting rates. Without actually cutting them.

The RBA are going to spend the next few months highlighting the economic weakness and making it clear that ‘accommodative policy’ will come at some point.

Basically, this sort of change in central banking language is part of a strategy called ‘forward guidance’.

Forward guidance is pretty much a central bank talking to, and about, the market. In other words, it’s the RBA telling investors and businesses that there will be changes, but don’t worry, we’ll give you plenty of warning before they come. It’s the ‘no surprises’ sort of central banking policy.

When central banks move to this, it tells you just how fragile the market really is.

Japan cuts rates and the US raises them

For the perfect example of what forward guidance looks like, look to none other than the Federal Reserve Bank.

The Fed spent all of 2015 warning, warning again and insisting that a rate rise was coming.

They had to. The American economy was so delicate, so fragile, that investors couldn’t handle the ‘shock’ of a rate movement without warning.

After 12 long months of talking and reassurance, the Fed finally cranked up rates from 0.25% to 0.5% in December last year.

The problem is, the US economy isn’t healthy.

Bloomberg wrote over the weekend that fourth quarter GDP data says the US economy can’t handle a rate rise, saying:

Gross domestic product rose at a 0.7 per cent annualised rate in the three months ended in December after a 2 per cent gain in the third quarter, Commerce Department figures showed on Friday. The advance was in line with the Bloomberg survey median forecast of 0.8 per cent.

“The economy perhaps isn’t quite as strong as we thought it was – there’s clearly some very weak spots, but there’s a solid foundation to growth,” said Nariman Behravesh, chief economist at IHS in Lexington, Massachusetts , who is the best forecaster of GDP over the past two years according to data compiled by Bloomberg. Even after the fourth-quarter slowdown, “the stars are aligned for consumer spending to return”.

Bloomberg then points out that consumer confidence is stable, and resurrecting the economy relies on consumption. Business aren’t borrowing, with the data showing the first drop since 2012. On top of that, there was a 38.7% drop in spending on mining, oil and gas well drilling rigs.

The rate hike came four years too late. That’s according to Jim Rickards, the strategist of Strategic Intelligence. Jim says, if the Fed increased rates back in 2011/2012, they’d have the room now to cut rates as the economic data gets worse.

Instead, the Fed are hiking rates as the US sleepwalks into a recession.

He argues that the US economy is too weak to support a rate increase, saying:

The US is heading into a recession and the Fed’s rate hikes will accelerate that eventuality. Slower growth and deflation will dominate the Fed’s preference for rate hikes.

Enjoy your rate hike on 16 Dec. But don’t breathe a sigh of relief. The guessing game will restart immediately. When is the next hike coming? How frequent will they be? In the absence of message discipline – there is none at the Fed – speculation will be more rampant than ever.

It will be interesting to see if the Fed hikes once, twice or three times before reality sinks in. The rate hikes will be over soon enough. Expect a new round of Fed easing to “stimulate” a flagging economy by mid-to-late 2016. No amount of forward guidance will change the hard reality of recession.

The US is raising rates into a recession. Japan has negative rates to increase inflation. And Australia is simply talking at the market with a ‘she’ll be right’ sort of attitude.

Cutting or raising rates, it doesn’t matter. Either way, 2016 will be filled with more central bank intervention than ever before.


Shae Russell

From the Port Phillip Publishing Library

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Since starting out in the financial markets over a decade ago, Shae has extensive experience across various aspects of the industry. Shae cut her teeth in the derivatives industry, teaching clients basic trading techniques with technical analysis.

Joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications, such as Australian Small-Cap Investigator, Gold Stock Trader and Microcap Trader. She’s spent the past two years however, honing her macro analysis skills alongside Jim Rickards, showing Australians how to invest and profit form global macro trends.

Drawing on her extensive experience, Shae is a contributor to Money Morning, and lead editor of sister-publication Markets & Money, where she looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.

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