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Will the BoJ and FOMC Follow the ECB's Lead?

Will the BoJ and FOMC Follow the ECB's Lead?

2016-03-11 15:13:00
James Stanley, Strategist
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Talking Points:

- After yesterday’s massive Euro-reversals, equity markets found solid footing throughout the Asian and European sessions to trade higher. The DAX has moved back to pre-announcement levels and with both the Bank of Japan and the Fed on the calendar for next week, potential for volatility remains high.

- Will the Fed and Bank of Japan follow the ECB’s lead in giving markets what they want in the form of more loose monetary policy? In Japan the question is deeper negative rates or increases to QE. From the Fed the matter of pertinence is whether they back off of further 2016 rate hikes.

- If the Fed sticks to a hawkish tune next week, talking up rate hikes later in the year, markets may see a strong reversal in the US Dollar, and that can change the context of the currency paradigm very quickly.

- If you’re looking for trading ideas, check out our Trading Guides, which include the DailyFX Top Trading Ideas for 2016 along with our quarterly forecasts. And if you’re looking for shorter-term ideas, check out our SSI Indicator. Click here for description.

Yesterday’s ECB decisions made for interesting reactions across markets

The ECB rolled out a litany of stimulus measures yesterday, and after initially looking to be positive for risk assets, a brisk turnaround took place during the accompanying press conference. We discussed that reversal in the article, And, it’s Gone: Euro Reverses.

The Asian session opened in a somewhat tepid manner, but eventually buying took over and that led into what has so far been a really strong European session. We’re now seeing stocks pop in the way that many would’ve expected after yesterday’s stimulus announcement. But is this in response to Mr. Draghi’s statement yesterday being construed differently after traders and hedge fund managers have had an evening of reflection, or is this more looking forward to the major Central Bank meetings for next week?

Next week brings both the Bank of Japan and the Federal Reserve. Each of these meetings can stoke significant volatility, and if we judge based upon the reactions from yesterday, liquidity will likely remain subdued as the potential for risk aversion remains high. As an example of the type of volatility that traders might be able to expect, we’re taking a look at the German DAX below.

Will the BoJ and FOMC Follow the ECB's Lead?

Created with Marketscope/Trading Station II; prepared by James Stanley

But if we scroll out to a longer time-frame, this recent run in stock prices might not look as strong, as the weekly chart has produced a doji, with a resistance inflection off of the under-side of a 5+ year channel. This point of resistance is also at the 61.8% retracement of the most recent major move.

Will the BoJ and FOMC Follow the ECB's Lead?

Created with Marketscope/Trading Station II; prepared by James Stanley

The Bank of Japan is On Deck

The previous BoJ meeting turned out to be pretty disastrous: The bank made an unexpected move to negative interest rates which, by design, should spurn capital flows out of the currency. The exact opposite happened, and massive Yen strength emanated from that move to negative rates. With hindsight it appeared that this surprise move shocked markets to the point of risk aversion.

The big question is whether they’ll take that risk again, or whether they’ll look to extend of increase their QE program. But this may not be so easy, as the Bank of Japan already owns a significant portion of the Japanese Government Bond market, and they may have to look long and hard to find assets that they can even buy with more QE. This has already been an issue, and this is likely one of the reasons that we saw the bank add-in purchases of ETF’s to their QE outlay in 2014. But this hasn’t really worked out too well either, as the Japanese Government Pension Investment Fund reported a massive drawdown after the initial throes of volatility found its way into markets in August and September of last year.

At this point, on the heels of the outsized move by the ECB, the Bank of Japan may not even need to formally announce an increase or extension to QE to propel risk markets higher. A simple mention that they’re investigating ways of doing more could be enough to further substantiate support.

The chart below shows the current setup in the Nikkei on the weekly chart, and much like the DAX, we’re at a couple of different interesting levels of resistance:

Will the BoJ and FOMC Follow the ECB's Lead?

Created with Marketscope/Trading Station II; prepared by James Stanley

Will FOMC go Full-Dove?

Shortly after that BoJ decision early next week we hear from the Federal Reserve for their March rate decision. And this has become the source of significant heart burn for portfolio managers of recent as the Fed’s stuck to a relatively hawkish forecast for rate hikes. Markets have disagreed vehemently, and after Chair Yellen’s Congressional testimony, we saw the market’s expectations for those rate hikes pretty much priced-out of the market for the remainder of the year.

But will they yield? There is a very legitimate reason for the Fed to want to get the American economy off of emergency-like policies of ZIRP. In December, Ms. Yellen said she felt a greater risk of recession if the Fed didn’t hike rates. But after that rate hikes, markets changed dramatically. The year opened with drubbings across equity classes, and this was largely equated to the convergence of themes in Oil, China and Interest Rates.

Surprisingly, the net impact of yesterday’s ECB decision was USD weakness along with Euro strength With a weakened US Dollar, even the slightest hint of a hike later in the year from the Fed at the June or September meetings could inspire a significant move of strength.

Will the BoJ and FOMC Follow the ECB's Lead?

Created with Marketscope/Trading Station II; prepared by James Stanley

--- Written by James Stanley, Analyst for DailyFX.com

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