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December 11, 2023 - Can the Japanese spoil our Christmas ?



Equity and Bond markets continue to move higher, as the prevailing theme is that central banks will start cutting interest rates next year, rather aggressively. Historically, interest rate cuts have been very positive for both markets, but we must remind our readers that there have been very few cases when the interest rate cuts failed to ignite an equity rally (but bonds rallied). These few cases have been periods of extreme stress in the economies and rather sharp recessions, such as during the 2008-2009 crisis and the 2000-2003 bear market. There is no reason to believe that similar episodes can take place again, anytime soon. But the market view that we have moved in a perfect world where the economy is slowing but not collapsing and at the same time aggressive cuts are coming, could be challenged again.


Under this premise, the Bank of Japan December 19th meeting is definitely something to closely monitor. After almost a decade of no policy rate changes, the BoJ has perhaps started to set the stage for an exit from negative interest rates. It all started with Wednesday's comments from BoJ Deputy Governor Himino, who said "exiting negative interest rates could be beneficial for households and corporations". Then on Thursday, the focus shifted to BoJ Governor Ueda, who said "handling monetary policy will get tougher from year-end and through next year". In addition, he made a subsequent visit to Prime Minister Kishida's office to discuss policy. The implications of an earlier-than-discounted change in monetary policy could increase volatility in financial markets, and will make the JPY (Japanese Yen) rally. The japanese currency has appreciated against the USD by more than 3% this week and is 5% higher from the November 13 low. However, we should also note that an aggressive decision on interest rates as soon as next week will not be in line with the new Governor's style, who appears to be leaning more towards offering forward guidance rather than acting with surprise.


As a reminder, the BoJ is the only remaining major bank that still runs an ultra-loose monetary policy. With the country being in deflation (negative inflation) for decades, the Japanese authorities seem to be in denial and disbelief than the current inflationary environment is sustainable. Japan's CPI has been above the BoJ's target for more than a year now, and they still chose to hold firm on the stance of seeing inflation pressures as "transitory", much like J. Powell and C. Lagarde were seeing it in 2021, before their famous pivot which rattled the financial world in 2022. To their credit, the BoJ has made some changes in its monetary policy by allowing the 10-year bonds to trade at higher levels of yield than two years ago. This has pushed long-term bond yields to 1%, up from negative in late 2022. But exiting NIRP (negative interest rate policy) as the ECB did last year, is a different "animal" to tame, or rather a beast one would say.


But before the Japanese reveal their intentions ahead of the holidays, we have our own central bank meetings in Europe and the US, this week. Meetings by the ECB, the SNB (Swiss), the BoE (England) and Norges Bank (Norway) will take place on a single day alone, the "Super Thursday", December 14th. A lot of information will surface and which will be hard to digest all at once, but the common denominator will probably be a further confirmation that interest rates have peaked. However, with the recent steep drop in bond yields and the market's view that a significant number of rate cuts will be in the cards next year, some or all central banks might chose to verbally push against this.


The focus of the ECB meeting is going to be the new staff macroeconomic forecasts, which will include the year 2026 for the first time. The market's expectations are for lower growth and inflation forecasts for 2023 and 2024 and an unchanged inflation forecast of 2.1% for 2025. The brand new 2026 forecast should be 2.0%, i.e. in line with the ECB target. The discussion on the macro outlook will have even greater relevance following the recent release of better-than-expected November inflation data, which has led to a dovish repricing of the ECB rate outlook. The first cut is now priced for April and a cumulative 120bps of cuts are priced in, until end-2024. Given the recent macro data, it will be very difficult for the governing council and Mrs. Lagarde to spoil the party in the EUR bond market, although it is fair to say that prices (and yields) have moved past our short-term targets and a mini-correction will not be a surprise (lower bond prices, higher yields).


The FED's job is trickier than its peers, as the US economy has not yet shown the significant slowdown that the European data have revealed. This means that rate cuts across the Atlantic can not easily be justified with current information and the FED must offer its own view on Wednesday, when they will meet to decide on interest rates and also provide their new forecasts. It is hard to find the circumstances under which Mr. Powell says anything other than: "It's far too early to think about cuts; policy will need to remain restrictive; inflation remains well above target; the Fed will need to see a period of sub-trend growth". Yet, the market is pricing a total of more than 150bp of rate cuts to be delivered in 2024. The risk that the FED will push aggressively against this market view cannot be ignored.


The recent US jobs data did not offer any fresh information, rather than we what already know: the US labor market is cooling off but remains at a much better state than what is usually a precursor of a recession. The November non-farm payrolls moved higher to 199k, better than the 175k expected and higher than the 150k of October. The unemployment rate dropped to 3.7% from 3.9%. We have to make note that the numbers are influenced by a large number of workers who returned to their jobs after the strikes at auto manufacturers ended. On the other hand, the monthly job openings number (JOLTS) fell to the lowest level since March of 2021, at 8.7mn, which is lower than the 9.4mn of the previous month.


Equities moved further higher, especially in Europe, but bonds lost some ground. As we are moving close to the important central bank meetings, the markets see an increased probability of an ECB "pivot", or in other words, a change of monetary policy (rate cut) faster than the US. This was the main reason behind the 2%-2.5% further rise of European equities, while their US peers posted only marginal gains (S&P500 +0.2%). US bond yields moved about 10bp higher across the curve, after the jobs market data, while German yields remained close to their recent lows.


Oil prices fell to the lowest level since July, with WTI Crude back below 70$. Oil prices are now down more than 10% since the beginning of the year , due to various reasons, one of them being the potential collapse in demand if the European and US economies fall into a recession, at a time when the Chinese recovery has been anaemic. We made the decision to increase our exposure to Energy stocks, which has been low up to now. Acknowledging the fact that oil prices could slide further, we consider the share prices of Total, Shell and Chevron for example to offer a very decent risk-reward profile, at current levels. Apart from their very high and stable dividends, the companies offer exposure to the commodity and a natural hedge to the rest of the equity portfolio, in case there is an escalation in the current military conflicts or the erruption of a new one (God forbid).


Chart of the Week : Has the time come to own Japanese Yen ?



A disclaimer first: Forecasting foreign exchange moves is many times futile.

The above chart shows the evolution on EURJPY for the last 30 years. The higher the price is the more the Japanese Yen has fallen and the EUR has risen. And when the line drops, this means that the JPY has appreciated against the EUR. We see that since 2021, the JPY has been falling precipitously (EURJPY rising), impacted by the significant difference in interest rates between the two currencies, a bi-product of the totally divergent monetary policies employed by the two central banks. We can also see that the current levels of the EURJPY are not far from the previous peaks of the last 30 years, after which the JPY rallied significantly against the EUR (EURJPY falling). We are not currency forecasters and by no means we advocate that this is a "sure bet". But using history as a guide and the macro view that the interest rate differential will shrink, we could argue that the EURJPY can return back to levels closer to 120-130 from the current 155-160 , which means that the Japanese currency could rally more than 20%.


Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Factset Photo: Koichi Kamoshida | Getty Images News | Getty Image

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