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Last week, the world’s three most powerful central banks convened. Within 36 hours of each other, investors were expecting the Fed to raise interest rates, the European Central Bank (ECB) potentially fleshing out its plan to cease buying bonds, and the Bank of Japan maintaining its massive stimulus program. This is what actually happened:
The ECB outlined plans to end its massive stimulus program by the end of this year, but keep interest rates steady until next summer.
The ECB President Mario Draghi said that if data continued to come in line with the ECB’s forecasts, then its monthly bond purchase program would be extended through to the final quarter of the year, though at a slower pace. This means the program would likely end in December if the euro zone economy remained resilient.
Until now, this quantitative easing program was scheduled to last until September, with monthly purchases of €30 billion of government and private debt. This will be reduced to €15 billion during the last three months of 2018.
Furthermore, the ECB also indicated that a rate hike is unlikely to come before the summer of 2019, again depending on data.
The euro on Thursday suffered its worst day against the dollar since the UK’s Brexit vote nearly two years ago after the European Central Bank unexpectedly indicated that it planned to keep interest rates at record lows into the summer of 2019.
Last Thursday, the Federal Reserve raised interest rates for the second time this year and upgraded their forecast to four total increases in 2018, as unemployment falls and inflation overshoots their target faster than previously projected.
Also, the so-called “dot plot” released Wednesday showed eight Fed policy makers expected four or more quarter-point rate increases for the full year, compared with seven officials during the previous forecast round in March. The number viewing three or fewer hikes as appropriate fell to seven from eight.
What is the “dot plot”?
The dot plot is published after each Fed meeting. It shows the projections of the 16 members of the Federal Open Market Committee (FOMC), the rate-setting body within the Fed.
Each dot represents a member’s view on where the fed funds rate should be at the end of the various calendar years shown, as well as in the long run—the peak for the fed funds rate after the Fed has finished tightening or “normalizing” policy from its current levels. The dot plot represents the Fed’s ongoing effort to become more transparent with respect to its policies.
Bank of Japan Meeting
Bank of Japan maintained its monetary stimulus and lowered its inflation forecast, even as other major central banks resorted to tightening last week.
Governor Haruhiko Kuroda and his board members decided by an 8-1 majority vote to hold its target of raising the amount of outstanding JGB holdings at an annual pace of about JPY 80 trillion.
The bank will purchase government bonds so that the yield of 10-year JGBs will remain at around 0%.
The board also decided to maintain the -0.1% interest rate on current accounts that financial institutions maintain at the bank.
The economy is forecast to continue its moderate expansion. On the price front, the BoJ said consumer prices will rise in the range of 0.5% to 1%. Earlier, the bank projected inflation to move around 1%.
While the U.S. central bank is in the lead, the ECB’s pending pivot after more than three years of quantitative easing reflects mounting optimism that the world economy remains on track for a solid expansion in 2018 after a wobble in the first quarter shook investors.
Such confidence comes despite trade war threats by US President Donald Trump, the rise of a populist government in Italy, the costliest oil in more than three years and palpitations in emerging markets from Turkey to Argentina, factors, which all pose a challenge to growth.
We continue to expect 2018 to end the year with positive gains for global equities with particular preference to European and Emerging Market equities.
However, it is also true that pullbacks and volatility will become more common as investors adjust to rising interest rates. More volatility should not detail the underlying economic expansion or fundamentally dent risk assets, but it will make markets more bumpy and less predictable.
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