Central Banks Will Disappoint

Last week, markets got all excited about comments from Bank of Japan Governor Kuroda that Japan’s inflation is “finally close” to the BoJ’s 2% target. Overnight, there were suddenly all sorts of articles speculating on the end of the BoJ’s extraordinarily easy monetary stimulus.

This pattern happens time and time again. A Central Banker makes some conciliatory noises about how the economy is getting better, and then BAM! markets instantly start testing their resolve by pushing prices against the Central Bank.

And the recent market action has played out perfectly according to script. In the wake of Kuroda’s comments, JGB traders pushed the yield on the 10-year maturity right up against the upper range of the Bank of Japan’s yield target peg. How did the BoJ respond? In no surprise, instead of rolling over and allowing the market to dictate when the peg will end, the BoJ executed an open market operation where they bid 11 basis points for unlimited amounts of 10-year JGBs. Man, that must be a fun order for the BoJ traders to send down to their bond brokers.

“I am 99.90 bid the 0.10%’s of 27.”

“OK, paying 90. For how many?”

“unlimited…”

Someday this sort of Central Bank bravado will be punished, but that day ain’t today.

For now, markets don’t have the fortitude to break these Central Bank pegs, so interpreting some fleeting comment from a Central Bank governor as it indicates a policy change is the wrong play. Now I understand why this happens. Markets are rightfully scared about this possibility, but I almost think too many pundits are confusing their desire to have QE end with the message that Central Bankers are actually sending.

Whether it is the Bank of Japan defending of the peg or the ECB’s comments regarding recent Euro strength, these Central Bankers are in much less of a rush to ease off the accelerator than the market believes.

They will overshoot. The Bank of Japan especially has adopted Paul McCulley’s mantra that they need to be “responsibly irresponsible.” The BoJ has been burned too many times assuming that the economic recovery has become self-sustaining, only to find that as soon as they withdraw stimulus, the recovery falls on its face. They aren’t going to make that mistake again. No, the mistake they make this time will be completely in the opposite direction. Which is why it is foolish to constantly be looking for Central Bankers to ease off. They will do so only reluctantly and much slower than the market expects.