Why Even a Historic BOJ Rate Hike Has Failed to Save the Yen

Economic

Summary:

Japan's yield remains world's lowest, real exports stagnant.

Japan’s first interest rate hike in 17 years has failed to deliver the boost to the yen that policymakers had hoped for, with strategists pointing to four key reasons for the currency to remain weak for now.

At the top of the list is rates in Japan that remain much lower than the rest of the world, followed by speculation the yen hasn’t weakened fast enough to invite intervention, low market volatility that favors carry trades, and signs the depreciating currency isn’t bolstering exports.

While officials have said the yen isn’t moving in line with fundamentals, and that they will take appropriate steps to stem declines, the currency remains near the three-decade low of 151.97 per dollar set last week.

“The yen is likely to remain weak,” said Daisaku Ueno, chief foreign-exchange strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “Despite the rate hike, there’s no prospect to see positive real interest rates in the near term, which makes the appeal of the yen very poor.”

Low Yields

Source: Bloomberg

After accounting for inflation, Japan’s 10-year yield stands around minus 0.650%, compared with about 2% in the US and 0.27% in Germany.

That’s a huge incentive for traders to borrow in yen to invest in high-yielding assets in a strategy known as the carry trade. It’s a headache that just won’t go away for the Japanese government, which has to deal with political fallout of the weak yen pushing up the cost of living for households.

While the Bank of Japan is expected to increase borrowing costs further this year, as its major counterparts start to cut interest rates, the exact timing is uncertain and it will take time to meaningfully narrow the nation’s yawning yield gap with its peers.

“Surplus funds naturally flow from lower-yield places to higher-yielding countries, just like water flows from high to low,” said Ayako Sera, market strategist at Sumitomo Mitsui Trust Bank Ltd. “There’s no reason to keep surplus funds here where the policy rate is around zero.”

Intervention Uncertainty

Currency traders are on high alert for possible intervention to support the yen by Japan’s Ministry of Finance after officials ratcheted up their warnings. Yet the hurdle to leap from words to actions appears to be high.Traders focused on quantifiable guidance from the government’s top currency official, Masato Kanda, are looking to 10-yen moves over one month against the dollar as a key metric.

Kanda Index Suggests Yen Intervention Still Unlikely

Why Even a Historic BOJ Rate Hike Has Failed to Save the Yen_2

Source: Bloomberg

The yen still hasn’t moved that much in recent weeks, according to a gauge that measures the currency’s swings from its highest to lowest against the dollar in a rolling 28-day window. The last time the dollar-yen reached that threshold was in October 2022, when the Ministry of Finance intervened twice. It’s now less than half that level.

Japan is committed to international agreements calling on governments to allow markets to determine exchange rates. But there’s some scope for intervention in response to excessive moves.

Falling Volatility

Why Even a Historic BOJ Rate Hike Has Failed to Save the Yen_3

Source: Commodity Futures Trading Commission

Volatility has come down in the currency market, boosting the allure of carry trades for investors, who have less to worry about market fluctuations wiping out profits.

Leveraged funds and asset managers combined pushed up bearish yen bets to the most since April 2022 last month, according to data from the Commodity Futures Trading Commission. A JPMorgan Chase & Co. gauge of global currency volatility has halved from a recent peak in September 2022.

Falling Exports

Economics textbooks say that a weak currency should increase exports by making products more affordable abroad, and that the foreign demand will eventually strengthen the currency. But that’s not really happening now in Japan, with an export boost absent.

The yen’s nominal effective exchange rate, an indicator of the currency’s strength against those of Japan’s major trading peers, has slumped almost 25% since the end of 2020. But a BOJ gauge for inflation-adjusted exports has fallen 3.3% during the period.

Source: Bank Of Japan

That may reflect Japanese companies increasingly producing goods overseas rather than exporting, while fund flows out of the country to seek higher investment returns abroad also are a headwind for the yen.

An improved trade balance should be part of the adjustment process for a currency, Steven Englander, head of global G-10 FX research at Standard Chartered Bank, wrote in a research note last week. “The absence of such an improvement weakens the case for a yen rebound.”

Source: Bloomberg

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Economic

Data and Fed rhetoric weigh on Fed rate cut bets

At its latest gathering, the Fed appeared more dovish than expected, still pointing to three quarter-point rate cuts for 2024. This allowed market participants to add back to their June cut bets, lifting the probability for a 25bps reduction to around 80%.

However, this proved to be a temporary assessment. Last week, Fed Governor Waller said that the Committee is in no rush to start cutting interest rates, a view echoed by Fed Chair Powell on Friday, after the core PCE index came at 2.8% y/y, as it was expected. Will The NFP Report Take June Off The Rate-cut Map? _1

Will The NFP Report Take June Off The Rate-cut Map? _1

This allowed dollar bulls to jump back into the action, adding to their positions on Monday after the ISM manufacturing PMI for March expanded for the first time since September 2022. The prices subindex rose to 55.8 from 52.5, corroborating the outlook painted by the S&P Global flash PMIs for the month, which revealed that selling prices rose at the fastest pace in just under a year.

Combined with the upward revision of the Atlanta Fed GDPNow model to 2.8% from 2.3% for Q1, the latest developments prompted investors to push back again their rate reduction bets According to Fed funds futures, the probability of a first quarter-point reduction in June has dropped to around 65%, while the total number of basis points worth of rate cuts by the end of the year has been decreased to 68. Will The NFP Report Take June Off The Rate-cut Map? _2

Will The NFP Report Take June Off The Rate-cut Map? _2

From anticipating around 160bs at the start of the year, the market is now expecting less reductions than the 75bps projected by the Fed itself, which adds downside risks to the dollar in case of disappointing data moving forward.

Will further easing in labor market ring the alarm bells?

With that in mind, the next major event on investors’ agenda may be Friday’s US employment report for March. The unemployment rate is expected to have held steady at 3.9% and nonfarm payrolls are forecast to have slowed to 205k from 275k. That said, the rebound in the employment subindex of the ISM manufacturing PMI tilts the risks to the upside. Average hourly earnings are expected to slow somewhat to 4.1% y/y from 4.3%. Will The NFP Report Take June Off The Rate-cut Map? _3

Will The NFP Report Take June Off The Rate-cut Map? _3

These numbers point to further easing in the labor market, but they are far from suggesting that a rate cut is urgent. After all another month of above 200k jobs is very encouraging for the economy, while a wage growth rate at around 4% is unlikely to help inflation come down faster than previously thought.

Dollar may continue to outperform the euro

The dollar is likely to stay the course north especially against the euro, as according to money markets, a June quarter-point reduction by the ECB is more than fully priced in, while following recent dovish remarks by ECB member Villeroy de Galhau and Stournaras, there is a nearly 20% chance for a cut at the upcoming meeting on April 11.

Euro/dollar fell below the key support zone of 1.0795 on Thursday and accelerated its slide this week, headed for the very important area between 1.0655 and 1.0695. A decisive dip below 1.0655 could carry larger bearish implications and perhaps pave the way towards the 1.0520 barrier, marked by the lows of October 26 and November 1.

Nonetheless, in case the jobs report disappoints, the pair may rebound and break back above 1.0795, but for the outlook to start looking brighter, a move all the way above the round number of 1.1000 may be needed.

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Zi Cheng

Economic

Growth in the US services sector eased in March for a second month while a gauge of input costs slumped to a four-year low.

The Institute for Supply Management’s composite gauge of services fell 1.2 points to 51.4, largely reflecting a drop in the supplier deliveries index to a record low. Readings above 50 indicate expansion, and the March figure was lower than all but one estimate in a Bloomberg survey of economists.

The index of prices paid for materials and services decreased more than 5 points to 53.4, the lowest since March 2020, according to the report issued Wednesday.

Source: Insitute for Supply Management

That stands in stark contrast to ISM data earlier week showing a manufacturing input-cost gauge climbed to the highest level since July 2022, suggesting the pace of goods disinflation is leveling off.

The services price data may temper concerns that the Federal Reserve’s progress on inflation is at risk of stalling. Policymakers are tracking developments in the services sector, the largest part of the economy, for signs of easing price pressures as they debate when to reduce interest rates.

“The plunge in the prices paid index to the lowest level since the pandemic began implies that core services ex-housing inflation, aka supercore, will resume falling back toward its pre-pandemic normal rate,” Stephen Brown, deputy chief North America economist at Capital Economics, said in a note.

With the decline in March, ISM’s gauge of prices paid by services dipped below the manufacturing input-cost measure for the first time since May 2022.

Still, service-industry respondents noted “that even with some prices stabilizing, inflation is still a concern,” Anthony Nieves, chair of the ISM Services Business Survey Committee, said in a statement.

Nieves said on a call with reporters that because fuel costs are rising again, he doesn’t anticipate input costs for services to continue falling.

The overall services index was depressed by the gauge of delivery times, which dropped 3.5 points to the lowest in ISM data back to 1997. Signs of improving supply chains help explain why order backlogs at service providers shrank at the fastest pace since August.

Twelve services industries reported growth in March, led by accommodation and food services. Four indicated a decrease in activity.

The ISM new orders gauge fell to a three-month low, though remained consistent with resilient demand.

The group’s business activity index — which parallels its factory output gauge — showed the strongest growth since September.

The measure of services employment ticked up slightly but remained in contraction territory.

Meanwhile, an index of inventories at service providers retreated to the lowest level since the end of 2022. A gauge of sentiment about inventories, while still indicating companies see stockpiles as too high, fell for the second straight month.

Source: Bloomberg

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Zi Cheng

Economic

Federal Reserve Chair Jerome Powell signaled policymakers will wait for clearer signs of lower inflation before cutting interest rates, even though a recent bump in prices didn’t alter their broader trajectory.

Powell said recent inflation figures — though higher than expected — did not “materially change” the overall picture. He reiterated his expectation that it will likely be appropriate to begin lowering rates “at some point this year.”

“On inflation, it is too soon to say whether the recent readings represent more than just a bump,” Powell said Wednesday in the text of a speech at Stanford University in California. “We do not expect that it will be appropriate to lower our policy rate until we have greater confidence that inflation is moving sustainably down toward 2%.”

The Federal Open Market Committee held interest rates steady last month. Officials narrowly maintained their outlook for three interest-rate cuts this year, even as key inflation metrics have picked up in 2024. Powell and other Fed officials have repeatedly said they are in no hurry to cut rates, and that their moves will depend on incoming data.

Following the release of Powell’s prepared remarks, Treasury yields remained higher as did the S&P 500. Investors are putting roughly even odds on an initial cut in June, and pricing suggests they see a chance of fewer than three reductions this year, according to futures.

“Given the strength of the economy and progress on inflation so far, we have time to let the incoming data guide our decisions on policy,” Powell said in the opening remarks ahead of a fireside chat. “If the economy evolves broadly as we expect, most FOMC participants see it as likely to be appropriate to begin lowering the policy rate at some point this year.”

Powell’s prepared remarks reinforce those he’s made following the March meeting. They also suggest that the Fed is unlikely to reduce rates at their next gathering taking place April 30-May 1.

Inflation Gauge

The Fed’s preferred gauge of underlying inflation cooled in February after an even larger increase than previously reported in January, government data released Friday showed. Even so, the back-to-back increases in the core personal consumption expenditures price index — which excludes volatile food and energy costs — were the biggest in a year.

Powell said last month that an unexpected weakening in the labor market could warrant a policy response from Fed officials. The Fed will get another update on the health of the job market Friday with the release of the monthly employment report, which is expected to show a gain of 213,000 jobs in March.

Fed officials in March were split on how aggressive rate cuts will be this year. The central bank’s “dot plot” showed 10 officials forecast three or more quarter-point cuts this year, while nine anticipated two or fewer.

The Fed chair also used part of his speech to emphasize that the central bank makes its decisions independent from politics. Powell added that he feels it is improper for him to weigh in on other public policy issues, like climate change policies.

“Our analysis is free from any personal or political bias, in service to the public,” he said. “We will not always get it right — no one does. But our decisions will always reflect our painstaking assessment of what is best for our economy in the medium and longer term — and nothing else.”

Source: Bloomberg

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Alex

Economic

Labor markets across most of the developed world just keep on beating expectations, pushing back bets on interest-rate cuts as hopes grow that central banks can pull off a soft landing after all.

The reasons for the high demand for workers — an aging workforce, lack of skilled labor and companies hoarding staff — are holding firm even as economies start to slow.

In all, the unemployment rate in developed economies remains near a record-low, according to quarterly data from the OECD. The consequences of that resilience for borrowing costs triggered a selloff in stocks and bonds this week. World Labor Markets Defy Odds And Force A Reset Of Rate-Cut Bets_1

World Labor Markets Defy Odds And Force A Reset Of Rate-Cut Bets_1

While demand for workers may have waned from the initial post-pandemic surge, it’s still much higher than experts forecast it would be by now. In the US, for instance, the Congressional Budget Office last year forecast the US unemployment rate would hit 5.1% by now; it remains at 3.9% today.

Data due Friday is set to show the US economy added more than 200,000 payrolls in March, double the level that Federal Reserve Chair Jerome Powell has said is sustainable.

As a result, markets continue to recast their pricing for Fed rate cuts — the odds for a move in June have slipped to around 59% — and those forecasts could be pushed out again. They slipped below 50% briefly this week after strong US factory data.

The S&P 500 saw its worst day in almost a month on Tuesday and the US 10-year yield touched its highest level since November as investors started to come to terms with that shift.

Economists at Goldman Sachs Group Inc. estimate it would take an increase of 0.2 to 0.3 percentage points to the US unemployment rate to justify three consecutive Fed cuts this year.

It’s a similar story elsewhere, even in economies that are slowing.

In Europe, where inflation has cooled in recent months, European Central Bank President Christine Lagarde has cited pay increases as one of three main factors officials are watching. Investors have pushed back expectations for a first interest rate cut to June, while at the end of 2023 their bets pointed to a 50% chance of a move in March and certainty the ECB would have eased by its April meeting.

In Canada, where the population soared by the most in more than 60 years in 2023, the jobless rate has barely budged as employers soaked up the new workers. In New Zealand — which entered a double-dip recession — unemployment has only just reached 4% and in Australia, a surprise surge in employment in February pushed the unemployment rate back down to 3.7%.

Central banks have consistently cited tight labor markets as an inflationary force and one of their top considerations when deciding interest rates. Powell last week said the strong job conditions give officials more time to consider when to cut.

“The fact that the US economy is growing at such a solid pace, the fact that the labor market is still very, very strong, gives us the chance to just be a little more confident about inflation coming down before we take the important step of cutting rates,” Powell said at an event at the San Francisco Fed.

To be clear, inflation remains the north star for central banks and the primary driver of policy. Powell has also said recently that strong hiring on its own wouldn’t be a reason to avoid cutting rates.

Lagging Indicator

To be sure, jobs tend to be a lagging indicator with monetary policy taking about 18 months to filter through into the economy, so higher rates may yet take a toll. The UK in January registered its first increase in unemployment since July, but the rate remained below 4%.

As consumer price pressures moderate back toward central banks’ comfort zones, forecasts that mass unemployment would be needed to get inflation down now look misplaced.

Usually during an extended period of high interest rates, companies cut back on expansions. Not so this time. If anything, the jobs picture could remain tighter for longer as business sentiment and planned investment remain healthy.

“Many firms are likely engaged in labor hoarding,” said Citigroup Inc. senior global economist Robert Sockin. “Firms know how difficult it is to find and train workers, and likely do not want to go through the same process in several quarters time when demand is stronger.”

The JPMorgan/S&P Global manufacturing index expanded again in March with the highest reading since July 2022 as companies worldwide broadly saw higher orders and output. Business Roundtable’s CEO Index rose to the highest level since 2022 in the first quarter on higher capital spending, employment and sales expectations.

“Higher interest rates appear only to have destroyed demand for jobs that never existed, i.e. vacancies,” said Freya Beamish, chief economist at TS Lombard.

Source：Bloomberg

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Samantha Luan

Economic

Central Bank

Euro-area inflation slowed more than expected, cementing prospects for an interest-rate cut by the European Central Bank in June.

Consumer prices rose an annual 2.4% last month, down from 2.6% in February, in line with a Bloomberg Economics Nowcast model. Analysts predicted an increase of 2.5%. A measure excluding volatile items such as food and energy also eased more than anticipated, to 2.9%. Euro-Area Inflation Inches Toward 2% With Focus On June Cut_1

Euro-Area Inflation Inches Toward 2% With Focus On June Cut_1

The report adds to evidence that policymakers are on track to return inflation to the 2% target, allowing them to soon dial back some of the restriction needed after price gains surged into double digits. President Christine Lagarde has signaled a first cut in June — informed by fresh forecasts and an update on wage growth in the early months of the year.

Most of the Governing Council — including officials from Germany, France and Spain — have signed up to that timeline, with few clinging to hopes of an earlier move. Economists and money markets are equally aligned, suggesting it would take a big shock to change course.

Traders held wagers on the scope for rate cuts this year after the report, pricing three quarter-point reductions starting in June with the chance of a fourth at around 60%. That compares to as many as four cuts priced ahead of last month’s monetary-policy decision.

While shipping disruptions in the Middle East haven’t affected inflation in Europe much and last week’s collapse of a bridge in Baltimore — a key port for carmakers and other manufacturers — is also unlikely to do so, rising pay within the 20-nation euro zone may yet stoke prices.

Euro-Area Inflation Inches Toward 2% With Focus On June Cut_2

Chief Economist Philip Lane insists wage increases must continue to retreat for him to consider reversing some of the ECB’s past hikes.

While a key compensation gauge showed some moderation at the end of 2023, salaries continue to expand by more than 4%. That’s sustaining price pressures in services, where labor has an outsized impact on final costs.

Inflation in that sector remained at 4% in March, while the rate for non-energy industrial goods fell to 1.1%. Euro-Area Inflation Inches Toward 2% With Focus On June Cut_3

Euro-Area Inflation Inches Toward 2% With Focus On June Cut_3

Across the region, trends also diverge. Spanish inflation accelerated after the government removed some of the support put in place to keep a lid on energy costs, and Italy also saw an uptick. Meanwhile, German and French readings both showed that inflation eased for a third month.

Such trends make it harder to determine the optimal path following the ECB’s initial cut. Policymakers have already shifted some attention to discussing the pace of later steps, though insist that ultimately economic data will decide.

Lagarde, too, says the ECB will respond to new information as it comes in. “This implies,” she said last month, “that, even after the first rate cut, we cannot pre-commit to a particular rate path.”

Source：Bloomberg

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Warren Takunda

Economic

Commodity

Oil prices extended gains on Wednesday, as investors mulled supply risks stemming from Ukrainian attacks on Russian refineries and the potential for escalation in the Middle East conflict, while OPEC+ ministers made no changes to current output cuts in a meeting.

Brent crude futures for June rose 75 cents, or 0.84%, to $89.67 per barrel at 1130 GMT, while U.S. West Texas Intermediate crude futures for May gained 73 cents, or 0.86%, to $85.88 a barrel.

OPEC+ ministers made no fresh policy recommendations in a meeting on Wednesday, two sources said, after the group already decided to extend current production cuts until June last month.

Oil futures compounded Tuesday's gains, when both Brent and WTI climbed 1.7% to their highest since October.

Prices jumped higher on Tuesday after a fresh round of Ukrainian drone attacks on Russian refineries threatened to take even more of the country's processing capacity offline.

Investors were also concerned that conflict in the Middle East could spread, after Iran vowed revenge against Israel for an attack on Monday that killed high-ranking military personnel.

A wider conflict in the Middle East involving more oil-producing nations could cause supply disruptions. Iran, which provides support for the Hamas militia fighting Israel in Gaza, is the third-largest producer in the Organization of the Petroleum Exporting Countries (OPEC).

"The rise in hostilities in both hotspots pushed the price of the two crude oil futures contracts to their highest levels this year," PVM analyst Tamas Varga said of Tuesday's rise.

Bank of America Global Research raised its 2024 Brent and WTI forecasts to $86 and $81 a barrel respectively, it said in a note on Wednesday, on firming demand and escalating political tensions.

"Geopolitical turmoil has also boosted oil demand via longer trade routes and impacted supply by reducing refining capacity via attacks on Russian energy infrastructure." the bank said.

Elsewhere on Wednesday, Taiwan's strongest earthquake in at least 25 years briefly caused Formosa Petrochemical to halt operations at its Mailiao refinery as a precautionary measure, but works have since restarted.

The U.S. Energy Information Administration (EIA) will also release oil inventory data later on Wednesday. Data from the American Petroleum Institute reported crude inventories fell by 2.3 million barrels last week, traders said on Tuesday.