Before Bidding 2020 Good Riddance: The FOMC And BOJ

Next week is the last full week of 2020. But before it can be bid good riddance, the Federal Reserve and the Bank of Japan will hold policy meetings and a batch of high-frequency data, including the preliminary December PMI readings, will be released, which will give investors a better sense of the economic momentum going into next year.

Central banks and investors are wrestling with the same thing: a faltering recovery as the social restrictions disrupt economic activity, while at the same time being cognizant that the medium-term prospects have improved as the vaccines begin rolling out. Moreover, if the near-term has become more sobering, enthusiasm for the post-COVID-19 world in the second half of next year is, well, contagious.

The reflation scenario featuring pent-up demand for leisure and recreation services, tourism, and business travel resumption seems to be dominating client conversations and investment strategies as the year winds down.

What can monetary policy, with the unpredictable and variable lags, do under such conditions? The Bank of Japan will likely extend some of its special crisis programs aimed at ensuring ample funds for markets and secure corporate financing. In the scale of easing, extending of current facilities from the end of March next year through September, or possibly December, is a modest step, and the modesty of the step may preclude reducing its bond purchases. 

This seems especially true given Prime Minister Suga's fiscal stimulus (~JPY73.6 trillion or ~$710 billion). Both fiscal and monetary policy should continue to work together. The independence of the central bank is not at risk. After all, we are talking about an institution whose leadership has often come from former Ministry of Finance officials, including Governor Kuroda.

In the US, Yellen, like Geithner before her, is going the other way (from the central bank to Treasury), though it is unusual (Volcker went from Treasury to the Fed).

Consider, for example, that both the Japanese government and the central bank share a common concern over the viability of so many regional banks. Previously, the BOJ offered regional banks a positive return of 10 bp on some of their reserves if they consolidated or cut costs. In his first budget, Suga offed some fiscal inducements to the same end, including subsidies for mergers, promotion of digitalization, and review of antitrust regulations. 

The Federal Reserve operates in a different institutional setting. It is at odds with Treasury Secretary Mnuchin over the failure to extend several backstops. It is at odds with Congress over the need for additional fiscal support, which remains elusive despite months of talks and nearly everyone saying how beneficial it would be.

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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