Another week, plenty of action

There was plenty of action in the markets over the past week with lots of noise and anticipation over future central bank action. US equities were up by 1.6% last week, Euro stocks increased by 0.4%, Japanese equities were down 0.2%, Chinese equities lifted by 2.1% and Australian shares were down 0.9%. Global bond yields lifted this week with the US 10 year yield at 2.54% – back to March 2017 levels.

However, the US dollar didn’t budge higher and fell by 1.1% last week. European bond yields were lifted, particularly in Germany and France, as markets read the latest commentary from the European Central Bank as hawkish, which also pushed the euro higher. Japanese bond yields and the yen rose on speculation that the Bank of Japan was going to tighten the monetary policy.

Commodity prices remained elevated, particularly oil prices, which are sitting at nearly US$70/barrel on concerns over tensions between the US and Iran together with some recent supply constraints. Energy stocks have also benefited from higher oil prices. The latest moves in the oil price are unlikely to be a hindrance on global growth. However the moves will lift headline inflation in the near-term.

The news that the Bank of Japan (BoJ) was trimming its purchases of government bonds was taken by investors as a sign of monetary policy tightening. However, the central bank didn’t actually give any formal guidance around its policy stance, so the news looks to have been slightly misinterpreted by markets. The BoJ is far from tightening interest rates, with its current policy of negative interest rates and targeting the bond yield working well. Inflation is still closer to 0%, rather than the 2% target, so a change to the current monetary policy stance is some time away.

Reports that China is looking to buy less US bonds also caused a further leg up in bond yields, but there is no sign that this has actually been adopted as official Chinese policy.

The ECB December meeting minutes were read as hawkish. It appears that the Governing Council is preparing markets for a future adjustment to monetary policy with the minutes indicating “the Governing Council’s communication would need to evolve gradually if the economy continued to expand and inflation converged towards the Governing Council’s aim”. It was noted that the current stance of monetary policy was in line with policy that was better suited to crisis mode.

There was more conversation from US Federal Reserve officials about potentially adopting a different monetary policy targeting mechanism with the latest talk about price-level targeting, which was recently mentioned by San Francisco Fed President Williams as well as the former Federal Reserve Chair Bernanke.

A price-level monetary policy target will aim to maintain a certain level of prices, rather than price growth (which is what the current inflation-rate target does). In practice, a price level target would mean that the central bank would be more reactive to deviations from the price-level because it would not look through temporary deviations from an inflation rate (as is currently done). This would also mean that inflation would tend to be more volatile with periods of very low inflation (or deflation) followed by periods of high inflation to make up for prior misses.

It is generally thought that price-level targeting will favour a “lower for longer” approach in monetary policy which suits the current environment as the US Federal Reserve has been noticeably shy of its 2% inflation target for years.

The discussion has come about as policymakers consider tools available in the case of an economic downturn. While the US Federal Reserve may explore its options around its monetary policy framework and what other tools are available to it, a change to its current framework is unlikely in 2018 which will be the first year for new US Federal Reserve chair Jerome Powell.