The Fed Turns Hawkish, The BoJ Doesn’t

What We Learned From Central Banks This Week

The date that I’ve had circled on my calendar for weeks, if not longer, as a potential game changer for the markets - the December Bank of Japan meeting - ended up creating little drama. The BoJ ended up holding rates steady, as was the likelier outcome heading into the meeting, but the 8-1 vote to delay a rate hike proved that there actually wasn’t much chance at all they were going to raise rates. Even a January hike is now viewed as roughly a 50-50 proposition.

The event that actually ended up inducing volatility was the Fed meeting. The quarter-point rate cut was essentially a done deal heading into the meeting, but the market seemed caught off guard by how hawkish of a cut it was. While most market watchers were expecting a “3 cuts in 2025” forecast from Powell, the Dot Plot ended up indicating just two and essentially pushed the rate cut calendar out by another 12 months. They also projected inflation to remain elevated throughout 2025 before getting back close to the 2% target in 2026. For what it’s worth, the Fed also projects no recession or rise in the unemployment rate for at least the next several years, but they never do.

So what does the Fed’s surprisingly hawkish and the BoJ’s surprisingly dovish stances post-meeting mean for the markets and the economy as we head into 2025?

The Dollar

The Fed announcement on Wednesday shot the dollar higher and the BoJ announcement on Thursday continued the momentum. As it stands, the dollar index is at 108.4, which is its strongest since the 2nd half of 2022.

If the dollar’s performance is going to be based on a combination of U.S. economic growth relative to the world and interest rates relative to the world, there’s a pretty cut and dry case of why the dollar is going to get stronger from here. China is still slowing down and who knows what the government is going to do in terms of stimulus. Japan’s decision to pause on rates suggests they’re worried more about growth than inflation at the moment. Europe is struggling mightily, especially the manufacturing sector, and recession there might be imminent.

The ECB looks like it’s going to cut rates several times next year, which will likely weaken the euro. The yen continues to go lower in the absence of higher rates. The Bank of England might be the only major central bank poised to keep rates at a high level for longer, but they only account for a little over 10% of the dollar index basket. It’s unlikely to be a game changer.

With the Fed only looking like it will make minimal rate cuts next year, the path appears to be higher for the dollar.

The Yen

The yen was weakening substantially in the lead-up to this week’s meetings as it looked less and less likely that the BoJ would hike. That intensified post-meeting after the central bank’s more dovish than expected stance and the dollar/yen exchange rate is nearly up to 158.

Earlier this month, the market put the odds of a rate hike by the end of Q1 at roughly 90%. The number is likely lower today and any rate change might not come until March. That means there could be plenty of time for the yen to weaken further before a rate hike comes to the rescue. That assumes, of course, that the government doesn’t step in and intervene on the yen’s behalf. They’ve done that several times over the past couple years with minimal results to show for it. The 150 level used to be the trigger point. More recently, they’ve let the yen float briefly above 160. At some point, the BoJ might have to do something to defend the yen, but I can’t imagine them committing a lot of capital to do so.

A major impetus for a reversal of the yen carry trade might be off the table until spring.