Like spring rains falling
So too, Japanese prices
Continue to slide

Once upon a time there was a tiny thought about Japan tightening monetary policy.  This thought, which had been seen lurking in the shadows of markets for the past thirty years, was largely ignored by all the ‘right’ people.  The illiterati economic gliteratti were all quite convinced that this would never happen as Japan was in a death spiral of rising debt and a shrinking population.  According to all the classical economic texts, interest rates could never rise again.

Then, one day there came along a virus that disrupted the world.  All the ‘important’ people in all the major nations determined that shutting down all economic activity while simultaneously printing trillions upon trillions of dollars, euros, pounds, and yen, and more importantly, giving that money to the people, was the best thing to do.  Not that surprisingly, with all that extra money chasing after fewer available goods and services, prices rose sharply almost everywhere.  Even in Japan, a nation that had suffered a generation-long deflationary bout, where companies literally apologized if they determined that a price rise was in order to cover rising expenses, prices started to go up more broadly.

This excited the policymakers in Japan as it was something they had been trying to achieve for the past 30 years.  It also excited the trading community as they became convinced that Japanese interest rates were set to explode higher.  And for a little while, Japanese inflation rates rose, surpassing the 2.0% target that had only been briefly brushed three times during that generation, the most recent being in the wake of the Covid actions.  Analysts were convinced that the new BOJ Governor, Kazuo Ueda, was getting set to raise the policy rate from its current level of -0.10%, its home for the past 8 years.  Traders positioned for JGB yields to rise and for the yen to strengthen against its currency counterparts.

Alas, so far this tale has not had that happy ending.  Instead, last night CPI in Japan printed at 2.2% headline, 2.0% core with both measures clearly trending lower for the past 18 months at least.  To be clear, in the very short term, these prints were marginally higher than market forecasts, which has resulted in a touch of strength in the yen (+0.3%), and a 1bp rise in 10-year JGB yields.  But bigger picture, this has further called into question the idea that Japanese inflation is going to remain stable at the BOJ’s 2% target.  In this situation, the idea the BOJ will tighten policy seems increasingly remote.  As such, all those delusions of tight money have been, once again, laid to rest.  The moral of this story is that; in Japan, the only money is easy money!

The newest Fed member has spoken
And Schmid said that things just ain’t broken
Thus, patience is needed
And so, he conceded
No rate cuts, not even a token
 
The Kansas City Fed’s new president, Jeffrey Schmid, made his first public comments yesterday but it could well have been his predecessor, uber-hawk Esther George, given that he hewed to the party line as follows:, “With inflation running above target, labor markets tight, and demand showing considerable momentum, my own view is that there is no need to preemptively adjust the stance of policy.  I believe that the best course of action is to be patient, continue to watch how the economy responds to the policy tightening that has occurred, and wait for convincing evidence that the inflation fight has been won.”  That’s pretty clear, and while he is not a current voter, it is simply another voice telling us that the Fed is not anxious to alter policy at all.  Even the market gets it now, with the March meeting down to a 0.5% probability of a cut, the May meeting down to a 16.3% probability and even the June meeting down to a 60% probability.  For all of 2024, the market is now pricing in just 3 ½ cuts, pretty darn close to the last dot plot.  Kudos to the Fed for getting their message across.
 
However, beyond those two stories, there is precious little to discuss this morning.  Data, beyond the Japanese CPI, has been sparse and the ECB speakers have also stayed true to their recent mantra of no reason to cut rates yet.  As such, it is not that surprising that markets remain mired in tight ranges overall.
 
Looking first at equity markets, after a lackluster session in the US yesterday, Japanese share prices were essentially unchanged although we did see some strength in Chinese shares with both the Hang Seng (+0.9%) and CSI 300 (+1.2%) rallying nicely on the back of increasing hopes for more Chinese stimulus coming in March at the annual plenary sessions.  As to the rest of Asia, activity was mixed with some countries seeing gains (India, Australia) and some losses (South Korea and Taiwan).  European bourses are also mixed with some gainers (Germany) and losers (Spain) while others have gone nowhere at all.  Finally, at this hour (6:45), US futures are ever so slightly firmer, just 0.1%.
 
In the bond market, both Treasuries and European sovereigns are seeing a bit of buying with yields lower by 1bp across the board.  Yesterday’s US 5-year auction was also somewhat unloved with a 0.8bp tail, quite large for that maturity.  It does appear that there is increasing pressure on the Treasury market as the pace of issuance picks up.  Over time, I believe this is going to matter a lot more to markets than it has thus far.
 
Oil prices, which rallied most of yesterday, are giving back some of those gains, down -0.4% this morning.  The rally was ostensibly based on further Red Sea concerns, but that really doesn’t make much sense given there were no new events there.  More likely, there was some short covering and analysts were looking for a story to tell.  Metals markets, though are in better shape this morning with gains in both precious (gold +0.3%) and base (copper +0.2%, aluminum +1.0%), largely on the back of the dollar’s modest weakness.
 
Which brings us to the dollar and the most confusing part of the session.  While it is true Treasury yields are lower by 1bp, that does not seem enough to weigh on the dollar, especially given the universal nature of yield declines.  The US curve actually inverted further, with the 2yr-10yr spread back to 42bps (it had been hanging around 25bps-30bps for several months), so that could be weighing on the greenback.  But whatever the cause, we are seeing pretty uniform weakness, although other than ZAR (+0.75%) which has clearly been helped by the metals rally, the rest of the movement is pretty modest, +/- 0.2% or less with more currencies gaining than losing.  I do not believe that the reaction function has changed here.  Rather, sometimes the FX market moves in funny ways.
 
On the data front, this morning brings Durable Goods (exp -4.5%, +0.2% ex transport) and Case-Shiller Home Prices (6.0%).  Yesterday saw a softer than expected New Home Sales and a weaker than expected Dallas Fed survey, although it was better than January’s print.  As well, we hear from Vice Chairman Barr, but there has been very little wavering from the message that patience is a virtue, and I don’t expect Mr Barr will change that tune.
 
The equity bulls took a rest yesterday but are clearly looking for more reasons to get back to buying.  To me, the potential problem will be home prices as, if they continue to rise, it will reduce hopes for any rate cuts at all, and there are still a number of pockets in the economy that are highly reliant on low interest rates to succeed.  Commercial real estate is simply the most frequently discussed, but consider much of the tech sector, where ideas that had been funded with free money that will not get the time of day if there is a cost of capital.  Ultimately, nothing has changed my idea of the dollar benefitting further as the market continues to understand that the Fed is not set to cut rates any time soon.  Of course, Thursday’s Core PCE could change a lot of views, mine included.
 
Good luck
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