Divergence: Rate Cuts, Pauses, and Hikes

Central bank policies are set to diverge from the steady hikes characterizing the first half of 2023, contributing to increased market volatility for the remainder of the year.

The rate hike cycles for the biggest central banks, the U.S. Federal Reserve and the European Central Bank (ECB), appear to be over. Last week's meetings by the Fed, ECB, and Bank of Japan (BOJ) revealed important policy changes that may continue to impact markets in the months to come. This week, other central banks will be cutting, pausing, or hiking rates. Central bank policy is now diverging, with the Bank of Brazil and other emerging-market economies expected to start cutting rates, joining the People's Bank of China in a more accommodative monetary policy. In contrast, the Reserve Bank of Australia is on pause and the Bank of England is likely to continue to hike rates.

Bank of Japan

As we wrote in February (Are You Focusing on the Wrong Central Bank?), the anticipated policy changes that BOJ was likely to make over the next six to nine months may affect the markets. Last week, the BOJ tweaked its yield curve control (YCC) policy, shifting from a hard cap on the 10-year Japanese government bond (JGB) yield at 0.5% to instead offering to buy 10-year bonds at 1.00%. Their remarks stated that 0.5% is now a reference point and not a ceiling. This adds yet another step in the BOJ's end to its easy monetary policy. Global stocks, bonds and currencies could be volatile as a result.

Bank of Japan widens yield curve control range

However, the BOJ is not yet convinced deflation is no longer a concern. While inflation is above its 2% target now, inflation in Japan may recede quickly if it continues to track the Purchasing Managers' Index (PMI) input prices index, which has tended to lead the consumer price index (CPI) in Japan by six months, as you can see in the chart below.

Inflation could be at 2% target by year-end in Japan