Tuesday September 20

Stocks finished marginally higher leading into the FOMC meeting tomorrow. The S&P 500 and the Dow Jones each rose less than 0.1% to 2,139 and 18,129 respectively. Utilities underperformed the broader market today while the KBW Bank index outperformed. Investors are largely expecting that the Fed will not raise rates tomorrow, however a “hawkish hold” is also being considered by analysts. That would entail holding rates at this meeting however strongly suggesting that tightening this year was likely. The market for Fed funds futures is reflecting a 20% chance of higher rates at tomorrow’s meeting. Leading into the meeting the 10 year Treasury yield finished 2bp lower than 1.69% and the two year fell 2bp to 0.77%. Accordingly 2yr vs 10yr was unchanged at 0.93%. The dollar put in mixed performances. USD rose 0.2% against EUR to $1.1156. USD fell 0.2% against JPY to Y101.74. USD rose 0.35% against GBP to $1.2985. Oil prices diverged a little. WTI rose 0.7% to $43.59 while Brent fell 0.4% to $45.75.

Monetary easing have proved to be profitable for central banks over the last 10 years. The eight largest central banks last year returned $149bn to their governments, which represents profits from monetary policies. This compares to just $40bn that was remitted to governments in 2005. The total has been rising significantly each year since 2005, and the proportion as a share of total government revenues is also on the rise. In Switzerland, the US, and Ireland central bank remittances make up more than 1% of total government revenues. The profits come from buying government bonds and other assets and make loans to other banks. In Europe, national central banks in weaker countries have been more profitable than central banks in core Eurozone countries such as Germany or France. That is because the weaker economies rely on their central banks more to make loans to banks.

The JGB yield curve has been bull flattening significantly over the last six years which is potentially creating problems. In 2010 the 2yr vs 10yr reached as high as 1.2%, however now it stands at less than 0.3%. Earlier this year it touched as low as 0.05% immediately after the Brexit. Some analysts are anticipating that the BoJ will seek to steepen the yield curve as part of its new monetary policy approach later this week. The BoJ could do this by buying more short dated bonds relative to longer term bonds. In theory a steeper yield curve is indicative of higher growth and inflation expectations. However right now given the economic  climate in Japan growth and inflation expectations are both very dismal. It could be that the BoJ seeks to foster these expectations by first steepening the yield curve and hope that higher inflation comes into fruition as a result. While normally the cause (higher growth and inflation) would lead to an effect (steeper yield curve), some analysts are expecting the BoJ to turn that relationship on its head. This would be considered a back-to-front monetary policy. This approach would help banks, whose net interest margins have been decimated by falling yields.
Tuesday September 20

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