Fed down,. BOJ to go

Macro Man saw the Fed statement as generally quite neutral.  To be sure, the elimination of "global risks" language and the emphasis on labor market improvement in the context of a slowing economy were both illustrative of a more upbeat Fed.   On the other hand, the statement still appeared to be relatively downbeat on inflation and highlighted ongoing weakness in breakevens despite the recent recovery.  In fairness, 5y5y breakevens remain lower on the year, though it seems evident that the FOMC isn't a big believer in technical analysis:

As Macro Man suspected, they once again left the balance of risks language on the shelf.  This would appear to be a wise choice, as it grants the committee maximum flexibility to interpret future events without the shackles of prior guidance to shade their viewpoint.  To use a musical analogy, the Fed thought that they were playing "I Walk the Line" between hawk and dove; the bond market, on the other hand, only heard "Pour Some Sugar on Me".  

Why is that?  Well, in refusing to provide more explicit guidance, the Fed has essentially delegated the policy decision to the market.  After all, as Macro Man discussed last month, the Fed has never, in the last two decades-plus, hiked rates with the market pricing less than a 50% chance of a tightening.  Asking bond market investors to unilaterally vote for tightening is akin to asking turkeys to vote for Christmas: it just ain't happening.    And so we're left with candlestick formations on a range of US fixed income charts that look suspiciously like interim bottoms.

The Fed, of course, was just the hors d'ouevres to tonight's BOJ announcement.   Although market commentators are generally supposed to have forthright views (preferably expressed with 100% confidence intervals), Macro Man cannot shake the notion that it is very difficult to have an edge in gaming this announcement.   Not only is it ostensibly uncertain whether the BOJ will actually do anything (though after recent rhetoric, it strikes Macro Man as very likely that they do), but the nature of any policy shift (more negative rates? negative loan rates for banks?   more QE via ETF buying?) and the market reaction are also dubious.

The degree of uncertainty is clearly reflected in option market pricing; the current overnight vol level prices the straddle at roughly 1.5%, implying hold to maturity breakevens of 110 and 113 by 10 am NY time on Thursday.  For part of Wednesday, that overnight vol price captured the Fed meeting as well, but as you can see the price barely budged after the FOMC statement was released.

That Macro Man kind of thinks that that vol might be a small sale despite the uncertainty over the BOJ outcome and reaction says quite a bit about how tangled the set up is.  A couple of things do seem reasonably clear, though.  The market is pricing at least some chance of a rate move; yen LIBOR, which usually moves with a degree of alacrity that makes a sloth look like Usain Bolt, has fallen nearly 4 bps over the last few weeks as the BOJ has ramped up the rhetoric.

Meanwhile, after previous BOJ policy moves (April 2013, October 2014, and this January), the Nikkei and USD/JPY have always been higher at least two days following the announcement than  they were the day before the announcement.  This would suggest buying USD/JPY and/or Nikkei near current levels (111.50) as a very short term punt.

Whether the BOJ can engineer a more permanent shift in market trends is up for debate.   Macro Man is somewhat skeptical- they are running out of securities to buy and NIRP has yet to demonstrate that it is much beyond a headwind for banks.  Obviously, helicopter money could be a game-changer, but Kuroda pooh-poohed the idea recently.   Then again, he derided the prospect of negative rates a week or so before cutting in January, so anything is possible.   Hmmm.....