Between Federal Reserve Chairman Bernanke and Bank of Japan Governor Kuroda, they have unsettled investors and injected volatility into the capital markets that has not been seen for some time. The markets are trying to return to some semblance of stability ahead of the weekend, but the ripple effects are still evident.
The Nikkei initially retraced some of yesterday's steep losses, before selling off more than 3.5% through yesterday's lows and then recovering to finish 0.9% higher. The stock market and the yen have not been the subject of BOJ concern as much as the JGB market. Purchases of another JPY900 bln of JGBs (five year maturities and longer) coupled with yesterday's JPY2 trillion money market injecting helped stabilize the bond market, but the 8 bp day's range shows that volatility remains highs and the market's unsettled.
The essence of Kuroda's challenge is to navigate the critical contradiction at the heart of its monetary policy. The BOJ wants to keep rates down and boost inflation expectations and revive the economy. It is a classic scissor. The more successful the BOJ is at the latter the less successful it will be in the former and vice versa.
Bernanke's comments at midweek to the Joint Economic Committee of Congress injected extra volatility into a nervous market. Many observers see two messages. The first, in prepared remarks, touted the same position as outlined in the FOMC's recent statement, but answers to questions seemed take a different tact and a less dovish one.
To understand Bernanke's message, one needs to understand who he was arguing against. He was responding to those who were skeptical of QE3+ and are concerned about the creations of other financial bubbles, and those, who the FOMC minutes identified as "several voters", that may be prepared to taper purchases as early as next month's meeting.
He was essentially saying, no, there will not be any tapering of purchases yet. That the Federal Reserve was closely monitoring the capital markets and the risk-reward favored the continued pursuit of the Fed's strategy. More data is needed to determine whether the economy has caught, in the sense of sustained growth. How much more data? A few more months.
Meanwhile, Bernanke's economic models, like many in the market, see the slowdown in the economy since March and are uncertain of the magnitude or duration. While weekly initial jobless claims show a labor market that is continuing to recover, non-farm payroll growth has slowed in March and April. The uneven pace of the recovery and the premature ending of QE1 and QE2 makes Bernanke cautious, while the low inflation readings provide a conducive environment to wait.
The economic news stream is fairly light. Confidence reports for the euro zone's three largest economies were released. There was modest improvement in Germany (IFO) and France (business confidence), while Italy reported a decline (consumer confidence). The German economy eked out a 0.1% expansion in Q1 and growth here in Q2 appears a little better. France and Italy are still contracting.
The euro has bumped up against the week's high near $1.30, which is also where the 20-day moving average is to be found and the 50% retracement of the decline from the May 8 $1.3200 high. A weekly close above there may help lift the technical tone. Sterling is considerably further away from the week's high (seen Monday near $1.5280). It has not been able to recover much from the double whammy of soft inflation and ugly retail sales. Meanwhile euro-sterling is at its best level since mid-April, testing GBP0.8600. Lastly, we note the dollar-bloc currencies continue to under-perform, though both the Australian dollar and Canadian dollar remain within yesterday's ranges.