February 1, 2016
Prior Week Summary
Interest rates moved lower to end the week, capping a month that saw a nearly 40 basis point decline in the 10-year swap rate, bringing the curve to the lowest levels since mid-2013. The combination of a surprise announcement by the Bank of Japan, a weak GDP print, and a Fed statement that downgraded the inflation outlook weighed on the curve and has caused market participants to push out into the future expectations for any additional Fed tightening. As of this writing, the market appears to be pricing in only 1 hike in the 4th quarter, providing a stark contrast to the 4 quarterly hikes that were implied by the Fed’s December dot plot. Indeed, the Fed acknowledged that “inflation is expected to remain low … in part because of the further declines in energy prices” while at the same time recognizing the volatility in financial markets by “closely monitoring global economic and financial developments…and their implications for the labor market and inflation.”
On Friday, the Bank of Japan intensified their efforts to shore up inflation expectations by announcing negative interest rates on excess reserves. The BOJ has already embarked on three years of quantitative easing, currently buying ¥80 trillion in assets a year in this effort, leaving the Central Bank owning nearly 1/3 of the country’s bond market. The BOJ announced that it would cut the rate paid on required reserves to 0%, while charging 0.1% on excess reserves. The move makes the BOJ the second major central bank to set negative interest rates, joining the ECB, as well as the central banks of Sweden, Denmark, and Switzerland.
Lastly, the Commerce Department reported that GDP rose at a tepid 0.7% rate, as companies cut back on investments in equipment. The negative impact that producers had on the statistic failed to be offset by the relative strength in personal consumption.
The Look Forward
This week the market is expecting updating information on personal income and spending, the state of the manufacturing sector, and of course, non farm payrolls on Friday. Fed Vice Chairman Fischer will be discussing his economic outlook on Monday, speaking at a Council on Foreign Relations event.