Today’s FOMC statement takes a backseat to the devastation in Japan
While our thoughts and prayers remain focused on the people of Japan, the Fed meeting schedule marched inexorably onward. Today's statement was a little more upbeat on the economy than January's and consistent with recent data, so not a surprise. Noting that the recovery is on "firmer footing" and that "labor markets appear to be improving gradually," policymakers hedged themselves by pointing out that residential housing "continues to be depressed"… thanks for the reminder guys. The language on inflation was also firmed-up a bit, describing "recent increases in the prices of energy and other commodities," but they only expect those increases to "be transitory;" again no surprise, but the subject of great debate. Those debates however, take a backseat to the disasters in Japan. At times like this we need to be especially careful about knee-jerk reactions, so it might be helpful to step back and 1) review the major trends in place going into the disaster; 2) examine if the events will alter those trends; and 3) explore possible policy responses.
First off, most global risk markets had already begun correcting the frothy QE-induced rally before the disaster unfolded, but key support levels have not yet been breeched. While markets are literally and figuratively being buffeted by the winds of news out of Japan, it's no doubt difficult for investors to stay with a trend when things go all biblical on them, but for the most part reaction has been surprisingly muted as most post-March 2009 trends remain intact. Even though it appears that black swans are beginning to swarm - think Japan, Mideast, and Euro-peripherals - the S&P 500 (below) has so far experienced just a modest intra-day 6.18% drawdown in its liquidity-charged cyclical rally, 10yr Treasury yields have only really dropped to the bottom of their expected trading range in a mini flight-to-safety, and the CRB commodity index has fallen a still-tame 7.8%. The same can not be said for the Nikkei 225 Index, however, which at one point was down over 21% from pre-quake levels, clearly in the throes of a full-on panic. But history suggests that natural disasters like earthquakes and tsunamis rarely change an economy's growth trajectory and I think a 21% panic selloff may begin to signal opportunity. What throws a wrench into this event, obviously, is the uncertainty surrounding the potential for a full meltdown in the nuclear reactors, but a panicked market is one to keep your eye on.
Just as was seen during the 1995 Kobe earthquake, currency repatriation has kicked in, causing a spike in the exchange values of the yen. Layering reconstruction costs onto an already strained public finance system, along with the BOJ injecting 15 trillion yen into the money markets and doubling its asset purchases, suggests that the repatriation spike should not be too long-lived. The last thing this beleaguered export-led economy needs is a strong yen, and I expect it to begin weakening anew as a result of concerted policy actions. As for other central bankers around the world, the events in Japan must clearly be viewed as an economic depressant, at least in the near term. This in turn should give monetary policymakers enough scope to keep policy leaning to accommodative side a little bit longer than was thought a week ago… and remember, wasn't that supposed to be what the now two-year-old rally was all about?