BoJ Evaluates Interest Rate Shift Amidst Rising Inflation Trends

Economic

Summary:

Governor Ueda hints at a potential interest rate shift as Japan nears an escape from low inflation. The central bank remains cautious amidst economic uncertainties, emphasizing a patient approach to monetary easing.

The Bank of Japan's persistent efforts to steer the nation's economy towards price stability have taken center stage as Governor Kazuo Ueda hinted at a potential shift in interest rates. In a recent speech, Ueda acknowledged a gradual rise in the probability of Japan escaping its low-inflation environment, emphasizing the delicate balance the central bank is striving to maintain amidst uncertainties in economic activities both at home and abroad.

Ueda emphasized the Board's patient approach to monetary easing, carefully weighing the positive effects against potential side effects. A key point highlighted in the speech was the divergence in policy responses between the BoJ and other central banks, attributed to the differing situations concerning prices and wages. However, Ueda left the door open for a change in approach, stating that if the symbiotic relationship between wages and prices intensifies, and the prospect of achieving the 2% price stability target in a sustainable manner becomes sufficiently probable, the BoJ may consider adjusting its monetary policy.

Market Reaction: Nikkei 225 Climbs 0.26%

The impact of Governor Ueda's remarks was promptly reflected in the Japanese stock market, with the Nikkei 225 gaining 85.05 points or 0.26% to close at 33,254.03 on Monday. This extended the positive momentum from the previous session, where Wall Street's year-end rally spilled over into global markets. The US Federal Reserve's November inflation gauge, which fell below expectations, further fueled optimism as it approached the central bank's target level of 2%.

Despite the positive market sentiment, Japan faced a dip in both headline and core inflation readings, hitting a 16-month low the previous month. On Christmas day, investors navigated a quiet trading session, scrutinizing Governor Ueda's speech for insights into the central bank's future policy considerations. The governor emphasized that the BoJ is maintaining a highly accommodative monetary policy stance to safeguard the fragile economic recovery.

Sectoral Performance and Top Performers

In this subdued Christmas day trade, healthcare emerged as the leading sector, propelling the market's upward trajectory. Noteworthy gains were also seen in property, technology, and consumer-related sectors. Among the top performers were Nexon Co. (5.4%), NTT Data Group (4.5%), Lasertec Co. (2.8%), NH Foods (2.5%), and Takashimaya Co. (2.4%).

Investors are keenly monitoring developments as the BoJ navigates the delicate balance between sustaining economic recovery and achieving price stability. The potential shift in monetary policy, as hinted by Governor Ueda, adds a layer of complexity to Japan's economic landscape, leaving market participants on the edge of their seats in anticipation of future policy decisions.

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Kevin Du

Economic

Stocks

Inflation data out Friday showed the Federal Reserve continues to close in on its goal of returning inflation to 2% and puts the central bank on the path towards cutting interest rates.

Recession signals remain few and far between. Interest rates have moderated from decade-plus highs reached this fall. The Dow Jones Industrial Average (^DJI) and S&P 500 (^GSPC) are on the doorstep of record highs. And the Nasdaq Composite (^IXIC) is up over 40% this year.

In the week ahead, whether the stock market's rally will result in a record for the S&P 500 — the Dow hit a record last week — should be the highest drama to face investors this week amid a light economic schedule and a barren earnings slate.

Stocks Sit near Record Highs as 2023 Trading Wraps Up: What to Watch This Week_1

Inflation nears the Fed's target

On Friday, inflation data showed the Fed taking a crucial step towards returning inflation to its 2% target.

The Personal Consumption Expenditures Price Index showed prices on a "core" basis, which strips out food and energy and is the Fed's preferred inflation measure, rose 3.2% over last year in November. This was the slowest annual increase since April 2021.

But slicing this data more finely reveals the central bank has more or less reached its goal.

On a six-month annualized basis, "core" PCE came in at 1.9% in November.

"This week saw a renewed attempt from some Fed officials to push back against market expectations for interest rate cuts but, with core PCE inflation running at an annualized pace of below 2% over the past six months, this final flurry of hawkishness isn’t fooling anyone," wrote Andrew Hunter, deputy chief US economist at Capital Economics, in a note on Friday.

"There is mounting evidence that the post-pandemic inflation scare is over and we expect interest rates to be cut significantly next year," Hunter added.

Stocks Sit near Record Highs as 2023 Trading Wraps Up: What to Watch This Week_2

That the Fed will be moving to quickly cut rates next year has, in part, been supporting the market's rally in 2023.

And while many investors will remember this year for the AI-related hype that reignited the tech trade after a dismal 2022, the second half of this year has been all about rates.

An autumn swoon in the US stock market coincided with a surge in Treasury yields to 16-year highs as doubts about slowing inflation pressures — and, in turn, doubts that Fed policy would ease from 22-year highs — weighed on markets.

Recent data, along with the Fed's forecasts, put to rest many of these fears.

Chasing 2024

As the stock market has pushed toward record highs to cap 2023, forecasts for 2024 have already become stale.

Last week, the equity strategy team at Goldman Sachs revised their 2024 S&P 500 price target up to 5,100 from 4,700.

When many on Wall Street began rolling out their year-ahead forecasts in mid-November, the market wasn't yet convinced of the path forward for inflation, the economy, and the Fed.

Now, we round out the year with a broad consensus that inflation will ease, the economy will continue to grow, and the Fed will cut rates. In other words, a "soft landing" has become the base case powering markets higher.

Stocks Sit near Record Highs as 2023 Trading Wraps Up: What to Watch This Week_3

And as we round out two of the more adventurous years in recent market history, the team at Bespoke Investment Group on Friday flagged a few market stats that remind us history will likely relegate these post-pandemic spasms to the dustbin.

On Nov. 30, 2023, the S&P 500 closed at 4,567.80. On Nov. 30, 2021, the S&P 500 closed at 4,567.00.

In between, of course, investors endured the S&P 500's worst year in a generation and are on the cusp of seeing the index clinch one of its best five years since the financial crisis. But the further we move past this two-year period where stocks "went nowhere," the less we'll remember of the drama that filled both moments.

In this same vein, Bespoke noted that during 2022's sell-off, the seven largest stocks by market cap in the S&P 500 to start the year lost a collective $4.9 trillion. This year, those same seven stocks have increased their collective market cap by the same $4.9 trillion.

As 2024 approaches, Wall Street forecasts reveal investors will enter the new year with what we'll call cautious optimism. The S&P 500 gains, on average, about 9% per year; most forecasters are looking for something closer to a 5% gain next year.

The stock market rarely sees an "average" year. Since 1957, the S&P 500 has gone up 15% or more 33 times. Over the same period, the index has lost ground 15 times.

Against this backdrop, it seems clear Wall Street is again setting itself up to be wrong about where stocks land at the end of next year.

But as Bespoke's data makes clear, aiming for precision in a given year is a fool's errand, anyway — in time, the drama of any one year's gain or loss will be flattened. And the arc of market history bends one way, in the end.

Source: Yahoo Finance

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Alex

Economic

Central Bank

Across continental Europe and the UK, inflation rates are trending down, with euro-area inflation cooling the fastest among developed-market countries (Display).

While falling inflation rates have prompted renewed optimism from investors globally, we doubt that key data and central bank policies support imminent policy easing in the UK and Europe. We also believe that markets are now pricing in faster rate cuts than central banks are ready to deliver.

Central Bank Meetings: Bias Remains Hawkish

As expected, the Bank of England (BoE) left the bank rate unchanged at 5.25% at its December meeting. The Monetary Policy Committee again voted six to three in favor of a pause, with the three dissenters voting for a hike. The post-meeting statement was again hawkish: the BoE expects to keep policy restrictive for a long period, retaining the option to hike rates again. And despite recent positive data, key indicators of persistently upward-trending prices—such as services and wage inflation—remain worrisome.

The European Central Bank (ECB) also kept rates on hold, as expected, and its press-release language was also unchanged: core inflation had eased, but the ECB stayed focused on price pressures given strong growth in unit labor costs. And the Governing Council reasserted its determination to keep policy rates at sufficiently restrictive levels for as long as necessary.

It also brought forward the run-off of one of the ECB's main bond-buying programs, the Pandemic Emergency Purchase Programme, which will entirely discontinue reinvestment at the end of 2024. We see this as a further hawkish move; reducing the size of the ECB's balance sheet will tighten financial conditions. There was one dovish signal: the ECB's statement omitted a previous reference to inflation staying high for too long.

At the subsequent press conference, ECB president Christine Lagarde insisted that rate cuts hadn't been discussed and that such a discussion was premature—a strong move to push back against declines in market interest rates. However, as 2024 gets under way, we believe that weaker euro-area inflation and other data will pave the way to rate-cut discussions in the first quarter.

Rate Cuts Are Coming to Europe—but Not As Fast as Markets Are Pricing In

The BoE will likely be the last to cut rates, but will move aggressively when it does. For now, UK consumer price inflation remains well above target, and strong wage growth points to ongoing risks of knock-on inflation effects. During 2024, however, we think inflationary pressures should ease faster than the BoE anticipates.

Even so, the Bank's Monetary Policy Committee will likely need to be confident that consumer price inflation will return sustainably to the 2% target in the medium term before cutting. Hence, we expect a late start, with the first rate cut in September 2024 and further cuts at each subsequent meeting.

Market pricing, by contrast, implies an early but relatively smooth cutting cycle, with 115 basis points of cuts for 2024 and the first cut as early as May. We think this suggests implausibly large first-quarter 2024 declines in core inflation and wage growth. In the more likely context of weak but resilient growth in 2024, we think the BoE will remain particularly cautious before acting.

The ECB's December Eurosystem growth and inflation forecast remained conservative, suggesting more downward revisions ahead. In particular, the forecast projects core inflation to remain at 2.1% in 2026, owing to strong growth in unit labor costs and domestic price pressures. And while it lowered economic growth numbers for 2023 and 2024, it expects a strong rebound in 2025.

On that basis, we believe the ECB will continue to favor a patient approach, even though signs of falling inflation will soon become increasingly evident. We expect the ECB's first rate cut in June 2024, with 100 basis points of reductions for the year. The market is more aggressive, pricing in the first rate cut as soon as March and total cuts of 150 basis points in 2024.

Source: Alliance Bernstein

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Kevin Du

Economic

Stocks

Investors have pulled about a net $75 billion from hedge funds so far in 2023 and allocations to the $3.4 trillion industry have slowed, data from Nasdaq eVestment showed. The outflows come on the heels of some $112 billion that left hedge funds last year.

Hedge funds in 2023 averaged a 5.7% return this year through November, according to hedge fund research firm PivotalPath. Strategies focused on equities and credit were the best performers, while macro and managed futures lagged.

By contrast, the S&P 500 is up about 24% this year, as of Dec. 20. Hedge funds are also competing with returns from bond markets, which have perked up thanks to a late-year rally: Bloomberg's U.S. Aggregate Bond Index has risen 4.88% for the same period.

At the same time, elevated yields across asset classes have bolstered the allure of money markets and other short-term vehicles, where investors can collect around 5% or more with a comparatively low level of risk.

"Some strategies that historically have been very conservative, yielding 5%-6%, are less attractive now because investors can get similar returns in cash," said Fredrik Langenskiold, senior investment specialist, alternatives at UBP.

Strong performance in a wide range of asset classes puts pressure on hedge funds to boost returns next year. Rebecca Adel, at Societe Generale's EMEA capital introduction team, said allocators would be seeking double-digit returns in 2024 and are interested in credit, global macro, commodity and equity long/short strategies.

One potential strategy involves funds adopting "barbell" portfolios with corporate and structured-credit hedge funds on one side and macroeconomic hedge funds providing alternative exposure on the other, said James Medeiros, president of Investcorp-Tages, which has "funds of funds" investing in hedge funds and also runs its own trading strategies.

Bond-trading hedge funds may benefit as higher rates increase costs for cash-hungry companies that have bonds and loans due for refinancing.

"You can get sort of equity-like returns on bond products, which is pretty attractive," said Zhe Shen, managing director of diversifying strategies at TIFF Investment Management, advising endowments and foundations on hedge fund investing. Shen said they had also added macro strategies to portfolios.

The S&P U.S. High Yield Corporate Bond Index is up 10.74% year-to-date.

Others are looking at hedge funds that trade bonds in a range of different strategies: taking long and short positions, packaging up corporate loans into bonds, and trading the relative values between bonds.

Global bond traders tracked by HSBC returned about a positive 7% so far this year to Dec. 8, the bank said in a note to clients.

"Now it's a good moment for credit, because dispersion of returns is higher than in previous years, while rates and spreads are still appealing despite the recent rally," said Mario Unali, senior portfolio manager at Kairos Partners. The firm, which manages a fund of funds, aims to increase the credit component of the portfolio for the first time in 15 years, mainly in high yield.

Hedge Funds Seek Double-Digit Returns in 2024 After Year of Outflows_1

MACRO TRADES

Investors are also eyeing hedge funds seeking to trade on macroeconomic signals that affect assets from bonds to equities and commodities.

Global macro hedge funds are up 1.7% in 2023, hampered by this year's rollercoaster ride in markets and a banking crisis in March, compared to a return of 11.5% in 2022, PivotalPath data showed.

Hedge Funds Seek Double-Digit Returns in 2024 After Year of Outflows_2

Some investors are betting the strategies - which thrive on disparate global trends - will see a strong year in 2024, with central banks expected to loosen monetary policy at varying speeds.

While bond yields, which move inversely to prices, have generally eased in the last quarter of 2023, worries over bond supply could persist in 2024 and keep yields elevated. Concerns over bond issuance helped take Treasury yields to 16-year highs in October.

"There should be too much bond supply next year" given the "bad" fiscal positions of major economies, said Shun Hong Liu, chief investment officer of macro hedge fund Hong Investment Advisors.

One key element will be an expected slowing of the global economy, said Doug Greenig, chief investment and executive at Florin Court Capital, a $2 billion systematic hedge fund.

"The global picture going forward will be economic weakness, a negative for corporate profits," said Greenig. "Equity markets could end up in a tug of war between a lift from lower interest rates and a drag from fears about earnings."

Source: Reuters

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Devin

Central Bank

Economic

Five major banks including the Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp. lowered the rates for a slew of products including time deposits on Friday.

The cuts would be the third such reduction this year, following previous rounds in June and September. Rates for one-year and two-year time deposits were lowered by 10 basis points and 20 bps, respectively, and rates for three-year and five-year time deposits were cut by 25 bps. After the adjustment, the lenders pay an annual 1.45% for one-year time deposits, down from 1.55%.

The move effectively lowers the cost of funding for banks, helping to improve their profit margins which have come under pressure due to surging household savings and Beijing telling banks to keep lending to a beleaguered property sector and cash-strapped local governments. It will pave the way for the People’s Bank of China to guide the loan prime rates lower to support the economy without jeopardizing banks’ financial health.

China Mega Banks Cut Deposit Rates, Signaling More Policy Easing_1

“This is a step in the right direction. China’s interest rates are too high given the deflationary pressure it faces,” said Zhang Zhiwei, chief economist at Pinpoint Asset Management Ltd. “I expect LPR cuts in the first half of 2024.”

Chinese banks kept the LPRs unchanged this week as the PBOC recently stood pat on its so-called medium-term lending facility, following a cut in August.

Economists expect lending rates to be lowered as soon as January. This is because pressure on the yuan has eased amid signs the Federal Reserve is nearing the end of rate hikes, allowing China to step up monetary easing.

Analysts at Tianfeng Securities forecast the PBOC will cut its policy rates — including the MLF — by 10 basis points in January, leading to a similar decline in the LPRs, according to a note Friday. Nomura Holdings Inc. see a 15-basis point cut to the PBOC’s policy rates each in January and April 2024.

China Mega Banks Cut Deposit Rates, Signaling More Policy Easing_2

Other easing measures are on the cards. Pinpoint’s Zhang expects the PBOC to lower the reserve requirement ratio, referring to the amount of cash banks must hold as reserves, before the Lunar New Year break in early February.

A lower RRR will free up long-term cash for banks to expand lending or buy more government bonds which will be issued to support the economy. The cuts to deposit rates spurred a drop in some ultra-long yields to the lowest in almost two decades, as the move may steer investment toward the debt market.

Bruce Pang, chief economist for Greater China at Jones Lang LaSalle Inc., said a RRR cut is possible in January. Authorities are seeking to first “stabilize banks’ net interest margin so they can serve the economy in a more sustainable manner, before pushing them to lower financing costs,” Pang said.

China’s escalating push to have its banking behemoths backstop struggling property firms has added to a maelstrom of woes for the $57 trillion sector. Banks’ net interest margins slumped to a record low of 1.73% as of September, below a 1.8% threshold seen as necessary to maintain reasonable profitability. Bad loans have hit a new high, and a revenue growth streak since 2017 for some of the nation’s largest state banks may snap this year.

Economic data released for November showed China’s economic recovery remains under pressure from weak demand and a lingering property crisis. Lowering deposit rates may give banks more room to provide better terms on corporate and home loans. It could also encourage households to shift away from bank deposits toward other investments and consumption.

Chinese households increased the share of their income that they save during the pandemic — boosting new savings by a stunning 80% in 2022 — and shifted their financial assets toward bank deposits, hitting the performance of funds that buy stocks and bonds on behalf of households.

Persisting pressure on banks means any cut to lending rates will likely be moderate. Ming Ming, chief economist at Citic Securities Co., estimates the latest deposit rate cuts will lower commercial banks’ average costs for deposits by 3 to 5 basis points. That means the scale of a potential reduction in the five-year LPR — a reference for mortgage rates — will be limited, he said on Friday.

Furthermore, with the economy still suffering from low consumer and business confidence, weakening demand, a worsening property sector, as well as a turbulent geopolitical landscape, several economists argue that the impact of monetary easing has been on the decline.

“Merely cutting rates and the RRR are unlikely to jumpstart the faltering economy,” Nomura economists including Jing Wang wrote in a note Friday.

Sources:Bloomberg

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Kevin Du

Energy

Palestinian-Israeli conflict

Oil prices fell over $1 a barrel on Thursday after Angola announced its departure from OPEC, while record US crude output and persistent worries over Red Sea shipping added further pressure.

Brent crude futures dropped $1.30 to $78.40 a barrel in afternoon trading, bringing losses to nearly 2% this week. US West Texas Intermediate (WTI) crude also slid $1.19 to $73.03 per barrel.

The declines came after Angola’s oil minister said the country will be leaving OPEC in 2024, saying its membership no longer serves national interests. While Angola’s production of 1.1 million barrels per day (bpd) is minor on a global scale, the move raises uncertainty about the unity and future cohesion of the OPEC+ alliance.

At the same time, surging US oil output continues to weigh on prices. Data from the Energy Information Administration (EIA) showed US production hitting a fresh peak of 13.3 million bpd last week, up from 13.2 million bpd.

The attacks on oil tankers transiting the narrow Bab el-Mandeb strait at the mouth of the Red Sea have forced shipping companies to avoid the area. This is lengthening voyage times and increasing freight rates, adding to oil supply concerns.

So far the disruption has been minimal, as most Middle East crude exports flow through the Strait of Hormuz. But the risks of broader supply chain headaches are mounting.

Balancing Act for Oil Prices

Oil prices have stabilized near $80 per barrel after a volatile year, as slowing economic growth and China’s COVID-19 battles dim demand, while the OPEC+ alliance constrains output.

The expected global demand rise of 1.9 million bpd in 2023 is relatively sluggish. And while the OPEC+ coalition agreed to cut production targets by 2 million bpd from November through 2023, actual output reductions are projected around just 1 million bpd as several countries struggle to pump at quota levels.

As a result, much depends on US producers. EIA predicts America will deliver nearly all new global supply growth next year, churning out an extra 850,000 bpd versus 2022.

With the US now rivaling Saudi Arabia and Russia as the world’s largest oil producer, its drilling rates are pivotal for prices. The problem for OPEC+ is that high prices over $90 per barrel incentivize large gains in US shale output.

Most analysts see Brent prices staying close to $80 per barrel in 2024, though risks are plentiful. A global recession could crater demand, while a resolution on Iranian nuclear talks could unlock over 1 million bpd in sanctions-blocked supply.

The Russia-Ukraine war also continues clouding the market, especially with the EU’s looming ban on Russian seaborne crude imports.

Impact of Angola’s OPEC Exit

In announcing its departure, Angola complained that OPEC+ was unfairly reducing its production quota for 2024 despite years of over-compliance and output declines.

The country’s oil production has dropped from close to 1.9 million bpd in 2008 to just over 1 million bpd this year. A lack of investment in exploration and development has sapped its oil fields.

The OPEC+ cuts seem to have been the final straw, with Angola saying it needs to focus on national energy strategy rather than coordinating policy within the 13-member cartel.

The move makes Angola the first member to leave OPEC since Qatar exited in 2019. While it holds little sway over global prices, it does spark questions over the unity and future cohesion of OPEC+, especially if other African members follow suit.

Most analysts, however, believe the cartel will hold together as key Gulf members and Russia continue dominating policy. OPEC+ still controls over 40% of global output, giving it unrivaled influence over prices through its supply quotas.

But UBS analyst Giovanni Staunovo points out that “prices still fell on concern of the unity of OPEC+ as a group.” If more unrest and exits occur, it could chip away at the alliance’s price control power.

For now OPEC+ remains focused on its landmark deal with Russia and supporting prices through 2024. Yet US producers are the real wild card, with their response to higher prices determining whether OPEC+ can balance the market or will lose more market share in years ahead.

Sources:channelchek

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Cohen

Forex

Europe’s biggest asset manager is shorting the pound on the conviction that the Bank of England will start cutting interest rates in the first half of 2024.

Why Europe’s Biggest Asset Manager Is Shorting the Pound?_1

Amundi SA anticipates that the UK currency will tumble more than 4% against the dollar as inflation slows and the economy shows the pain of policy tightening, according to Federico Cesarini, head of developed FX at Amundi Investment Institute, the asset management company’s research arm.

“We expect the pound to fall apart,” Cesarini said.

The BOE insisted last week that it still had a way to go to fight inflation and warned that it may even hike rates again. The pound has rallied over the past few weeks on expectations that the central bank will cut rates less aggressively than major peers, with net long positions in the currency at the highest in nearly three months, according to weekly CFTC data.

That was before data on Wednesday showed that inflation slowed more than forecast last month, paring some of the currency’s gains.

“We believe the current outperformance is totally not aligned with recession fears,” Cesarini said, with the economy looking set for another quarter of stagnation after gross domestic product fell in October.

Amundi expects the currency to fall as low as $1.21 in the first quarter, compared to this month’s high of near $1.28 and analyst forecasts of $1.25 by end-March, according to a Bloomberg poll. A recovery will see the currency strengthen to $1.24 by mid-year, around the time when Cesarini expects the Federal Reserve to begin cutting rates, and $1.29 by the end of 2024.

Cesarini said a resetting of many UK mortgages at decades-high interest rates will likely cause more financial pain, which will weigh on demand and ultimately growth. The further weakening of the economy would bring inflation sufficiently down for the BOE by May, paving the way for a first rate cut that month, he said.

“We have to remind ourselves that we cannot have seen the worst for the UK economy so far,” Cesarini said, adding that he expected the BOE to cut rates by 125 basis points next year. Markets are pricing in around 140 basis points of cuts by next December.