OPEC (the Organization of the Petroleum Exporting Countries) surprised markets by announcing a reinstatement of production quotas after abandoning that system amidst rampant violations from member countries. Though it is a modest reduction of between 200,000 and 700,000 barrels a day out of the current rate of 33.2 million barrels a day, the first announced production cut since 2008 lifted oil prices at month end. The plan is expected to be finalized at the November 30th meeting.
The European Central Bank (ECB) did not ease policy in its September meeting, despite European inflation failing to meet the ECB target for the past three years. ECB estimates that while inflation is expected to increase in Europe, it would still not meet the 2% target for the next two years. Mario Draghi, president of the ECB, also asked countries with “fiscal space” to engage in fiscal stimulus to supplement the central bank’s monetary stimulus. He mentioned Germany by name as a country with “fiscal space”.
With concerns mounting around the efficacy of its quantitative and qualitative easing (QQE) program, the Bank of Japan (BOJ) took non-traditional monetary policy to a new level at the September meeting. While not changing interest rates, the BOJ announced “yield curve control” at the meeting. According to the BOJ statement, the central bank “will seek to lower real interest rates by controlling short-term and long-term interest rates, which would be placed as the core of the new policy framework.”
The policy is intended to keep the 10 year Japanese Government Bond (JGB) around a 0% yield. By keeping deposit rates negative, the policy would ensure a spread between short and long rates, benefiting Japanese banks and other financial institutions. The new policy further allows the BOJ to incrementally ease monetary policy by changing the deposit rate, the long rate or adjusting purchases, which are currently set at ¥80 trillion (~$780 billion) for the year.
During September, dueling statements from Fed members led to increasing and decreasing expectations around a rate hike at the September 20 – 21 meeting. In the end, the Fed did not change interest rates at the meeting, in line with market expectations. The Fed statement noted that “the committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.“ Three voting members dissented in favor of an immediate rate hike, the most dissenters since December 2014. However, the ‘dot plot’ also revealed that three members did not expect any hikes for the remainder of this year. Given the November meeting does not include a press conference and is only days before the U.S. presidential election, most speculation around the next rate hike focuses on the December 13-14 meeting. At the end of September, Fed Funds Futures implied about a 62% probability of a rate hike by the end of the year.
In our view, while the focus of the coming weeks will likely be on the Fed and the U.S. presidential election, we do not expect either to fundamentally alter the fixed income landscape. If the Fed raises rates in December, it will have been a full year between actions, hardly a reckless pace and certainly consistent with our expectations of a slow, deliberate path. The election, while certainly unconventional, is more likely to cause angst than significantly shift the fundamentals underpinning the economy. U.S. growth and inflation are low, but better than previous periods and stronger than other developed nations. Job creation in the U.S., while volatile month-to-month, continues to exceed the population growth, which has been removing “slack” from the labor market. The impact of the progress on employment is being seen in wage growth as well as consumer spending, both of which support an improving economic landscape. Monetary policy in the U.S. is ever so slowly normalizing, but remains decidedly accommodative. The lean of policy and the accompanying yield environment is starkly different between the U.S. and other developed nations, continuing to support U.S. high quality fixed income. We expect noise in the coming weeks and months as the world parses poll data and statements from members of the Fed for their implications, but we remain focused on the fundamentals.
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