The second half of June looks like a treacherous time. As if the UK referendum on EU membership was not enough to unsettle investors, the Federal Reserve and Bank of Japan have just given investors two more reasons to be worried. The two central banks’ next meetings are scheduled for a week before the Brexit vote, with large dollops of unfinished business carried over from late April meetings. US and Japanese policy heading in opposite directions as the future of Europe hangs in the balance may not be a recipe for calm markets.

Ex-Kremlinologists have found a new vocation, parsing Janet Yellen’s every word for hints on the direction of Fed policy. The statement accompanying April’s no-change meeting in Washington left the door wide open to a June rate increase. Out went a reference to global economic and financial developments posing a risk to the US economy; in came nods to household incomes rising at a solid rate and improvements in the labour market. Both of these point to the Fed persisting with its tightening cycle.

As ever, Yellen has left herself with plenty of wriggle room. But June is very much a ‘live’ meeting as far as investors are concerned.

Expectation management as art form

The Fed has turned expectation management into an art form, unlike its counterpart in Tokyo which seems to have studied at the Mario Draghi school of communication. The central banks in Europe and Japan prefer a shock-and-awe approach to the markets. In their view, surprises are a good thing, maximising the impact of monetary policy shifts. As the dramatic reaction to the Bank of Japan’s unexpected inaction in April showed, however, it’s a risky strategy.

Almost everyone expected further easing by Bank of Japan governor Haruhiko Kuroda. Recent data made more stimulus a no-brainer. Japanese GDP shrank in the last three months of 2015 and growth is expected to hover around zero in the first half of this year. Inflation is non-existent – prices fell by 0.3 per cent in the latest quarter – and the central bank has again put back its forecast of when it will hit its 2 per cent target. Corporate earnings are being squeezed by an unexpected surge in the yen – it’s risen 10 per cent against the US dollar since January.

So why did Kuroda sit pat? And what does this mean for June’s meeting? There are a few reasons for the Bank of Japan’s do-nothing shock.

First, whatever Kuroda unveiled it might not have been good enough for a market that’s hooked on ever more stimulus. Faced with the prospect of a bad market reaction, he may have judged it better to hold his firepower. He will have been stung by the failure of his last bazooka – negative interest rates – to have the desired effect. The surge in the value of the yen since that move in January has been a salutary warning that central banks are losing their ability to manage markets.

Indeed the worry is that investors are instead managing the central banks. That provided a second reason to hold fire. The governor decided, probably correctly, that doing investor bidding would have dented his credibility even further.

A central bank stand-off

Finally, the decision to do nothing may be part of a stand-off between the central bank and Prime Minister Shinzo Abe’s government. Kuroda is unhappy that monetary policy is doing all the work. Japan faces another hike in its sales tax next April from 8 per cent to 10 per cent and many believe the government has no choice but to postpone the sales tax, even if that heaps pressure on a national balance sheet that is already drowning in debt.

Digging Japan out of its deflationary slump is proving a great deal harder than Abe and investors hoped when he swept to power in 2012 at the helm of a radical three-pronged strategy to make the country economically relevant again. This means further action in June is more likely than not. The success or failure of Kuroda’s approach matters for two reasons. First, because Japan is still the world’s third-largest economy. Faced with a fast-shrinking and fast-ageing population, the country needs to run fast just to stand still let alone return to growth.

Second, it is important because it emerged in April the world’s second largest economy is also saddled with debts worth 240 per cent of its economic output. If China were to follow Japan’s lead, dragged down by a mill-stone of un-repayable borrowings and bridges to nowhere, the world would really have a problem.

So, there’s a great deal at stake in June.

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