This week is set to be a big week, both in terms of the Becket household and global monetary matters. 
Starting at home, Betsy is making sure that everyone knows it is her 5th birthday on Wednesday; she is somewhat less excited about the imminent arrival of her youngest brother, who is now twelve days late and has to come this week.
Betsy is definitely completely unaware of the fact that Wednesday will bring the conclusion to the most recent phase of “will they or won’t they” from the Federal Reserve (Fed) and the latest mayhem from the Bank of Japan (BoJ)
Given how dull the last few weeks have been as I wait patiently for my long-suffering wife to produce our new son, it has to be said I am looking forward to it immensely.
Whilst the meetings in Washington and Tokyo are undoubtedly important, it should not detract from our general view that the central banks have done a frankly appalling job in the last few years.
Not only have they been consistently wrong in their forecasts, but they have shown precious little understanding for how the post-global financial crisis world is developing and both their communication and actions have been questionable, at best.
I was intrigued by the comments of the celebrated Mohammed El-Erian, former joint-CIO at PIMCO and probably the most heavyweight of all economic commentators, when he recently claimed that he thought the Federal Reserve was doing the best job of all the major central bankers and they should be applauded for their efforts.
I would make three points on this; firstly, Mr El-Erian is much smarter than me; secondly, the Fed might have done a better job than the Captain Calamities at other central banks, but we are talking seriously “soft comps”; but finally, in my view at least, they have done a poor job and have created more problems than help for investors.
In my opinion, the Fed has created chaos and confusion in markets in three ways.
Their primary issue is that they failed to raise rates two years ago when the US economy was in a decent enough state to start to move away from the emergency practices they implemented through the GFC and the “recovery years”.
Performance of index since Fed rate cut
Source: FE Analytics
Now is the wrong time to be raising rates, as economic momentum looks like it is slowing, rather than accelerating, and corporate profits have stagnated.
Secondly, they have given the distinct impression that they are dictated to by markets, rather than the other way around. Whilst understandable, this is just not the way it should be.
Finally, they just speak far too often; markets are being increasingly whipsawed on a daily basis by the latest contradictory guff that one member or another splurges.
Taking all the recent endless communication as a whole, we would not expect the Fed to raise rates at this meeting, as it would surprise markets and they hate that concept, but they will look to guide markets to a December hike.
Whether or not they will be able to depends on how things pan out from here. Markets imply a 50 per cent chance and we would agree that we are in a “coin-toss” situation with regard to whether they raise rates or not this year. Either way, their forecast of four increases from the start of 2016 will not be achieved.
The Bank of Japan’s situation is more difficult than the set of challenges that the Fed have and this makes this the most important of the two meetings this week, in our view.
The Bank of Japan has assumed the role of chief scientist in the ongoing monetary experiment that has been pursued by global central bankers and their success or failure will be vital for how the next few years pan out.
The simple fact is that investors believe that the Bank of Japan’s experiment has failed and credibility in them has collapsed.
The yen has been unhelpfully strengthening and there is an argument that despite owning a terrifying amount of the bond market, they have lost control of the “long end”, judging by the rise of long-dated borrowing costs.
Relative performance of currencies in 2016
Source: FE Analytics
Kuroda-san, the governor at the BoJ, has certainly tried to help Japan’s economy move out of a two-decade long period of stagnation and we respected his early efforts when he caught markets by surprise with his hyperactivity.
However, the more recent decisions made in 2016 have seemed poorly thought out and plain random, particularly when the BoJ cut their deposit rate to -0.10 per cent, despite Kuroda-san denying that he had contemplated such an action only a few days previously.
In our view, it was this decision that sparked the extraordinary rally we saw in global sovereign bonds, as Japanese investors and institutions flooded out of their own bonds and into international bonds in an attempt to achieve a safe yield.
Performance of indices in 2016
Source: FE Analytics
This has started to reverse since the BoJ “lost control” of the long end, which again shows the outsized importance of the BoJ’s actions.
For the upcoming meeting, the BoJ has signalled that their policy board would be presented with a “comprehensive assessment” of the effectiveness of its monetary policy settings.
However, we believe that their conclusions will come too late to spark a new path at this upcoming meeting and we would look to November’s meeting for any action. However, if Kuroda-san is able to get back to the form he initially showed at the BoJ and create a market-friendly surprise, then Japanese equities could continue their recent good performance and start to lead global markets again rather than lag.
This could well be wishful thinking in the short term, based upon recent disappointments.
For all the importance that markets have ascribed to the policy decisions of central bankers and the fact that I have written about it today, we would remind our clients and readers of the blog that we see the actions of central bankers as totally separate to the investment rationale we make for specific investments.
Japanese equities appear cheap and their US peers seem expensive, hence why we are overweight in the former. However, in the short-term we would like no surprise from the Fed and a positive surprise from the BoJ.
I’m not sure it is what Betsy wants for her birthday, but her Dad certainly wouldn’t mind such gifts.
Tom Becket is chief investment officer at Psigma Investment Management. All the views expressed above are his own and should not be taken as investment advice.