Jean Bovin – Head of BlackRock investment institute, together with Wei Li – Global Chief Investment Strategist, Alex Brazier – Deputy Head, and Ben Powell – Chief Investment Strategist for APAC all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
Assets at risk: The Bank of Japan looks set to change its ultra-loose policy as inflation takes root. We see spillover risks to global yields, risk appetite and Japanese stocks.
Market backdrop: Global stocks fell last week and U.S. Treasury yields rose across the curve as markets partly priced out Federal Reserve rate cuts later in the year.
Week ahead: The U.S. CPI is due this week. The December core CPI was revised up sharply last week, showing it hadn’t slowed nearly as much as first reported.
Japan’s economy is starting to look like its developed market (DM) peers at least in one way: Inflation is beginning to take root after having been long missing in action for decades. Yet the Bank of Japan’s ultra-loose monetary policy remains, including a cap on bond yields that requires sizable bond purchases. We think a policy change could come at any moment – scrapping the cap risks pushing global yields higher and reducing risk appetite. We cut Japanese stocks to underweight.
Inflation comes to Japan
Inflation – long missing in Japan – has reached four-decade highs on a weaker yen and higher energy prices. Crucially, that’s now feeding into higher wages. See the chart. We think that paves the way for the BOJ to roll back policies that by its own measures may have achieved their goal: to foster a sustained rise in inflation toward its 2% target that is underpinned by wage growth. The BOJ’s monetary easing went further than other major central banks with relentless bond buying to cap yields and large-cap stock purchases. Governor Haruhiko Kuroda has led the effort as one part of former Prime Minister Shinzo Abe’s fight against deflation, dubbed “Abenomics.” With wages rising by the most in decades, the BOJ can start winding down these policies. Yet doing so is unlikely to be easy without stirring market volatility. We see any Japanese yield spike from scrapping yield curve control as a global risk that could drive other yields higher and hit risk appetite.
Speculation is rising on what a BOJ leadership change in April will mean for policy. Kuroda’s last meeting as governor will be March 10. But we think who succeeds is less important than the fundamental issue: a nearing shift in policy. Regardless of who takes over, we think the wage and inflation dynamics at play mean the current policy stance has likely run its course. Policy changes could come in different forms. The BOJ could widen the band on its 10-year bond yield target again – market pricing not impacted by the cap is already up to 0.5% higher than that limit. We also think the BOJ could abandon its yield curve control at any moment. That would push yields higher and stoke interest rate volatility. It would put the BOJ on track to stop bond purchases – it owns over half of outstanding Japanese government bonds – potentially let its balance sheet shrink as bonds mature and push up policy rates.
Global ripple effects
We see global implications of a BOJ policy shift. A gravitational pull among developed market bond yields increases the risk of a global spillover, in our view – especially if Japanese investors cut their large foreign bond holdings. We see the jolt from a BOJ policy shift as another driver of higher term premium, or the compensation investors demand for holding long-term government bonds. We think the risk of further rises in global yields could dampen global risk sentiment. The policy change could put the BOJ on course with a larger trend by major central banks to boost yields rather than depress them. The BOJ would then join the quantitative tightening push, with the Federal Reserve doing so now and European Central Bank soon.
These risks prompt us to downgrade Japanese stocks to underweight. Monetary policy uncertainty and the sensitivity of Japan’s economy to the slowdown in other major economies spur the change. Declining earnings growth estimates already reflect some risks from slowing growth – we expect Japan’s export sector to suffer. But we do see the positive undercurrents of corporate reform, a result of one of the economic initiatives in Abenomics known as the “third arrow.” Japan has become a more shareholder-friendly market, in our view, with companies boosting share buybacks and dividends. We prefer unhedged Japanese equity exposures for foreign investors given the policy risks – and we also favor sectors that stand to benefit from automation, digitalization and tourism.
We see a BOJ policy shift driving the risk for higher global yields. That reinforces why yield is back – and why we tactically prefer short-term government bonds and credit for income. We downgrade Japanese stocks on policy uncertainty and a worsening economic environment. We prefer emerging market stocks on a relative basis to DM equities..
Global stocks fell last week and U.S. Treasury yields rose across the curve as markets partly priced out Fed rate cuts later in the year. We think the risk asset pause shows we’re at a critical crossroads. The messages from Fed officials last week were more clearly about not being done in fighting inflation. Fed Chair Jerome Powell last week stressed the inflation fight will “take quite a bit of time.” We think policy rates could stay higher for longer than the market expects.
Feb. 14: U.S. CPI inflation; UK jobs data
Feb. 15: UK inflation; U.S. retail sales; U.S. and euro area industrial production; Japan trade
Feb. 16: U.S. housing starts
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