Time Out? ECB, BOJ Have Markets Rethinking NIRP
- It appears that a global détente has been called in the FX wars.
- Reconsideration of NIRP throws recent optimism into question.
- As FX market volatility stays elevated, it's a good time to review risk management principles.
All of the sudden, markets are reconsidering their more optimistic views from the past month. The introduction of the Bank of Japan's negative interest rate policy (NIRP) on January 29 was seen as signaling the next wave in central bank stimulus, and the sentiment that the European Central Bank would ease in March and that the Federal Reserve would refrain from raising rates in March was enough to keep market participants happy.
However, on the eve of the March FOMC meeting, too many instruments are moving in tandem to ignore the short-term development in psychology. First, it was last week with the ECB introducing deeper negative rates - with a twist. Instead of appearing to be aimed at weakening the Euro, instead NIRP is being applied by the ECB to help stimulate lending activity. Second, in its meeting overnight, the BOJ indicated that it needed "some time" to assess its recently instituted NIRP policy, all while exempting money reserve funds (MRFs) from the negative rates. Like the ECB, the BOJ has pledged to do more if it deems necessary.
Both of these developments are material changes in our understanding of policy and thus the impact they will have on their respective currencies. There is a conclusion being drawn out after the last few days of activity: central banks realize that their NIRP policies have technical limits, especially in tradeable markets, but can be effective at changing incentives along the credit transmission channel. For both the BOJ and the ECB, NIRP will not be applied carte blanche.
If negative rates are limited in scope going forward, this may throw into question the improving sentiment picture, which has been built up upon rising commodity prices and higher equity markets since mid-February. In a world of increasingly negative yields, investors are forced to reach into riskier asset pools in order to achieve their required return; hedging this risk of diluted fiat, stronger Gold and Crude Oil emerged as early winners.
Now, both Gold and Crude Oil are looking like their recent month-long uptrends could be thrown into question - technically speaking, both are losing their bullish structure. See the video (above) for technical considerations in EUR/USD, AUD/USD, GBP/USD, USD/JPY, SPX500, Crude Oil (USOIL), and the USDOLLAR Index.
--- Written by Christopher Vecchio, Currency Strategist
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