Market Review & Outlook: Major central bank activity to end with Bank of Japan

A flurry of major central bank activity has dominated the markets in recent weeks as we approach the end of a roller-coaster year for the markets. This barrage of December policy decisions began last week with the Reserve Bank of Australia (RBA), Bank of Canada (BoC), and European Central Bank (ECB). The roster continued this past week with the US Federal Reserve, Swiss National Bank (SNB), and Bank of England (BoE). Finally, next week will round out the major central bank decisions of December and of the entire year with the Bank of Japan’s critical policy meeting early in the week.

To sum up the outcome of December decisions thus far:

1. RBA - Cash rate unchanged at record low of 1.50%, as expected. Key factors in decision: global economic growth, improving labor market, steadier China conditions, rising inflation and commodity prices.
2. BoC - Overnight rate unchanged at 0.50%, as expected. Key factors in decision: strengthening global economic conditions, though economic uncertainty remains. Inflation higher, but still somewhat below expectations.
3. ECB – Rates left unchanged as expected. Surprise: quantitative easing program of extensive bond purchases extended for longer-than-expected nine months – to December of 2017. “Tapering” of bond purchases from 80 billion euros/month down to 60 billion euros set for April of 2017.
4. Fed – Fed Funds rate raised by 25 basis points to 0.50%-0.75%, as expected. Surprise: “Dot-Plot” outlook indicates Fed officials now expect three further rate hikes in 2017 instead of previous expectations of two.
5. SNB - Negative target Libor rate unchanged at -0.75% (mid-price of –1.25% and –0.25%), as expected. Statement: “The negative interest rate and the SNB’s willingness to intervene in the foreign exchange market are intended to make Swiss franc investments less attractive, thereby easing pressure on the currency. The Swiss franc is still significantly overvalued.”
6. BoE – Official bank rate unchanged at record low of 0.25%, as expected. Neutral policy stance remains as central bank balances inflation, growth, looming Brexit process. Governor Mark Carney stated that BoE can now respond “in either direction.”

As might have been expected, the most dramatic market reaction to the recent parade of central banks occurred as a result of the hawkish Fed decision and the dovish-leaning ECB. The dollar surged sharply, which prompted a steep, extended dive for gold prices. At the same time, the EUR/USD, which had already been reeling from a longer-than-expected QE extension by the ECB, plunged dramatically on Fed-driven dollar strength. The currency pair swiftly broke down below major support around the 1.0500 level, which has opened the way towards a potential target at parity (1.0000).

As noted, the last major central bank decision of the year will occur early next week, when the Bank of Japan (BoJ) issues its monetary policy statement and holds its press conference. The BoJ is widely expected to keep its negative interest rates unchanged at -0.10%, and not to expand its already-massive stimulus program at the current time. Part of these expectations can be traced to the current Trump rally that has extended very conspicuously to Japan’s Nikkei index, and the recent sharp weakness in the Japanese yen as the dollar has surged.

Since Donald Trump’s victory in early November, USD/JPY has been on a relentless rally that has seen the currency pair breakout above major resistance levels, establishing new multi-month highs on a regular basis. As of this past week, USD/JPY has hit a new high well above the key 118.00 level as the Fed-driven dollar has surged and the yen has weakened across the board. The BoJ decision next week could lead to a modest rebound for the yen and a pullback for USD/JPY, especially if no changes are made as expected. However, the Fed’s hawkish influence will likely continue to dominate the currency pair, potentially extending the current uptrend significantly further. In this event, the next major upside targets are at the 120.00 psychological level followed by the key 122.00 resistance objective.