The aftermath of some of these events will be evident in April, including the weakness of the yen. As we have touched on before, despite the BOJ’s change in policy and the better economic picture in Japan, the same structural factors that have contributed to the yen’s weakness to date could continue, notably the structural flows out of Japan. Plus, carry trades play a role, given large interest rate differentials.
That being said, what are the arguments for yen strength? The yen has already depreciated significantly, Japan may have a high level of debt but it is domestically funded, and the economy appears to be in far better shape than when the yen’s depreciation began, with downside fears about deflation replaced by expectations now of both inflation and policy rates being higher than before, albeit still low.
Currency intervention aimed at deterring speculation and the view that the yen is a one-way bet is likely at some stage, but may only smooth its path and not prevent further weakness. Meanwhile, elsewhere, the Mexican peso remains strong, despite its central bank having already embarked upon monetary easing, in line with others in Latin America who had pursued previously more prudent monetary policies than the major western central banks.
Market attention will likely focus primarily on the backdrop to future interest rate decisions in the US, plus to a lesser extent the euro area and UK.
Our assumption has been for some time – and remains the case – that policy rates will fall in the US, UK and euro area before the end of the second quarter. Then, that there will be further gradual easing, before policy rates settle at a relatively high level compared with where they were before the pandemic. Although for those with a much longer memory, where policy rates settle will not seem low.
I think the Bank of England (BOE) tightened too much, and there is a strong case to cut rates, despite the pick-up in growth which is modest and as inflationary pressures are easing. Also, one should not overlook that despite speculation about when the first cut in policy rates will occur, there is still monetary policy tightening as the BOE is selling gilts via quantitative tightening.
I see policy rates at 5% before the end of Q2 and 4.5% by year end. As we noted last week the BOE minutes reflected a desire to see lower service sector inflation and wage growth, although after their policy meeting the Governor signalled a bias to ease. Inflationary data in the next two months will provide further evidence of easing inflationary pressures in the UK. Meanwhile, the US Federal Reserve (the Fed) will likely need evidence of easing core inflation before they embark on easing, with more debate about the timing of the first cut.
With the next policy meetings of the Fed and the Bank of England not until May, attention is likely to focus on the European Central Bank’s (ECB) April meeting. It is possible that the ECB eases then, although current market thinking is that they will wait at least another month. There are enough reasons for the ECB to ease monetary policy, with inflation easing and growth sluggish, but while president Lagarde’s comments might be consistent with an early cut, some concerns persist at the ECB.
April sees the spring meetings of the International Monetary Fund (IMF).
These meetings in mid-April will see the updated economic forecasts from the IMF, plus the release of their latest financial stability report and fiscal report, allowing one to assess where they see risks. Financial stability risks should be eased by lower rates, but it is the growth of the non-bank financial sector which accounts for a growing proportion of financial assets that warrants attention. Fiscal risks also may be eased temporarily by higher nominal GDP growth in many western economies. This allows the ratio of debt to GDP to edge down.
However, in reality, debt ratios, even after falling, will remain high in most major economies and be vulnerable if growth disappoints or interest rates do not fall too far and thus stay high relative to economic growth rates. It is the relationship between growth and interest rates that is critical in the debt outlook.
The IMF’s growth projections have pointed to modest growth globally in the wake of the post pandemic rebound. Before the global financial crisis, global growth on the IMF measure averaged 3.8%, with 3% then being seen as very weak.
At the time of their last World Economic Outlook in January, the IMF talked of global growth of 3.5% in 2022 and 3.1% in 2023 being followed by 3.1% this year and 3.2% next. It would not be a surprise to see a slight upward revision to their forecast for this year and next. A key component of that might be an upward revision to their view of the US.
In January the IMF talked of a soft landing for the US, which still seems right based on latest data and scope for some monetary easing. With inflation decelerating this should help growth prospects, not just in the US but globally. But even though growth may be recovering it is still modest compared with before the global financial crisis. Moreover, where inflation and thus policy rates will settle is still uncertain and will drive the focus of financial markets in coming weeks.
Please note, the value of your investments can go down as well as up.
