In the bond market’s view, the chance of a Federal Reserve interest-rate increase this year is practically a toss-up after the Bank of Japan’s surprise policy move.

Yields on sovereign debt fell worldwide after BOJ Governor Haruhiko Kuroda introduced negative interest rates for some bank reserves to support the world’s third-biggest economy. Derivatives traders see less than a 60 percent shot that the Fed will raise its benchmark even once this year, let alone the four quarter-point increases that policy makers projected in December.

The move from Japan is another sign of slowing global economic growth, which triggered volatility across global markets to start the year. The European Central Bank has also signaled it may add stimulus. The divergence between U.S. monetary policy and the stances in Japan and the euro region risk strengthening the greenback by driving global investors to higher-yielding American assets. That could further damp inflation in the U.S., which hasn’t reached the Fed’s 2 percent target since 2012.

David Fuller's view

The US is probably the most independent of the major economies but that does not mean that the Fed can act as if it is in a goldfish bowl. 

More than at any other time in human history we live in a global economy.  That is generally good for global peace and GDP growth, more often than not, although it may not feel like it.  That is because we are far better informed about what is taking place in every cranny of the globe, and our economies have yet to recover from the worst credit crisis recession since the 1930s depression.

Nevertheless, the US is leading a gradual global economic recovery.  The Fed’s dual mandates are employment and inflation.  The former was strong enough for the Fed to commence with its first rate hike in nine years last month.  Increasing employment accompanied by higher salaries on average has always been a harbinger of inflation.  Consequently, the Fed felt justified to announce in December that it was on course to raise rates four more times in 2016. 

Clearly the Fed was looking at US rather than international developments in December and it has subsequently had to mitigate that forecast.  Had it not toned down that view it would have risked another surge in the Dollar Index, more than capable of weakening the US economy and also causing problems for international corporations and countries which borrowed in dollars when the price was lower. 

With the Bank of Japan now joining the European Central Bank by introducing negative interest rates for some bank reserves, the risk of a too strong US Dollar remains.  Therefore, I maintain that the US Treasury will continue to intervene on behalf of the Federal Reserve, in an effort to keep the Dollar Index within its current range below the psychological 100 level.  This will continue to be done on a clandestine basis, for obvious reasons.

Meanwhile, the Fed’s next problem with the Dollar Index and its mandate on inflation will occur as the Continuous Commodity Index continues to recover from unsustainably low levels.  That will provide an uptick in inflation which technology can only mitigate over time.