Market Views

GLOBAL CREDIT BULLETS | Monday, 23 January 2023

Bank of Japan – Defying the inevitable (for now)
The BoJ surprised markets on Wednesday by leaving their yield-curve-control (YCC) policy unchanged, against market expectations of a widening of the target band or a removal of the policy altogether. Wage pressures keep rising in Japan (Uniqlo just asked for 40% wage rises for their employees), and on Friday CPI rose to a decade-high of 4%, with core at 3%. The BoJ now owns close to all outstanding 10Y government bonds, resulting a in poorly functioning market and a strongly dislocated yield curve. The price reaction to the surprise on Wednesday was reassuring however, as USDJPY rose by less than 2.5% and even fell quickly again after, now trading almost unchanged to before the meeting around 129. We think the BoJ is just postponing the inevitable and will eventually need to revise their monetary policy approach. Key catalysts to watch will be the choice of the new governor, who should be announced within the next month, and further wage developments in the country.

Eurozone – No time for doves
Dovish ECB members tried to push for smaller hikes this week, thereby attempting to steer markets away from Lagarde’s December guidance for two 50bp hikes in February and March. The doves make a case of falling inflation driven by lower energy prices. More hawkish members including Lagarde, Lane, Knot, Rehn and Holzmann quickly pushed back against this and said the guidance for several 50bp hikes remains valid. December core CPI rose to 5.2% earlier this month, and we think persistently higher wage growth in the Eurozone of 5-6% will keep core inflation higher for longer. In addition, European economic data is holding up well and business sentiment and surveys are improving. Paired with China reopening, we think the risks to European rates lie to the upside.

Markets – Bad news no good news anymore
US economic data worsened this week, with retail sales dropping by -1.1% MoM and the NY Fed Empire Manufacturing survey for current business conditions dropping to -32.9, much lower than the -8.7 survey. Since this week, we have noticed correlations turning whereby equities sold off as US government bonds rallied, following the classical negative correlation between the two prices. For a while, bad economic data was seen as good news, because it gave investors confidence that demand-pressures to inflation could eventually subside and the Fed could slow down. However, this narrative is now turning. Markets are becoming confident that US inflation will fall quickly (market pricing sees June inflation falling to 2.1% by June) and the Fed slows down to 25bps in February (market pricing implies 27.5bp). This means, bad economic news now signal a looming recession and should therefore be taking as negative news by the market going further. If data in the US continues to worsen, this implies more downside for risk assets, and more upside for government bonds.

UK – Strong data vs dovish BoE
This week’s data in the UK showed that labour markets remain tight and that wage pressures continue to rise. Average 3m weekly earnings rose to 6.4% up to November, and private sector wages even rose by 7.1%. CPI continues to fall from the highs, but core remains sticky at 6.3%. On Friday, retail sales excl. car fuel fell by -1.1% MoM and -6.1% YoY, with the ONS stating consumers are clearly scaling back non-food purchases. Consumer confidence fell by more than expected, too. The new wage data presents a headache for the BoE, which is looking to slow down their hiking pace as soon as possible. We remain of the view that the BoE will try to end hiking as soon as they can, but that 50bp for the February meeting is likely the base case. Afterwards, we need to see if the labour market can cool sufficiently for them to stop hiking by March.

Algebris Investments’ Global Credit Team

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