Europe – Rates to Rise Further.
Inflation data last week in Europe remained strong, strengthening the case for policy normalization. Germany month-on-month (mom) CPI inflation for March was at 2.5%, with France mom inflation at 1.6%, both higher than market expectations. The higher-than-expected inflation print was partly due to higher energy prices. This energy impact may also affect other global inflation prints, like the US CPI print on the 12th April. The week prior, European economic data (PMIs) had also been stronger than expected, albeit weaker than previous months. This weekend, ECB governing council member Schnabel said the data supports policy normalization, calling for an interest rate hike after winding down bond purchases in Q3. Schnabel said that while the war increases uncertainty and downside risks to growth, a “considerable” part of inflation may be persistent due to structural changes and wage catch-up.
Bank of Japan – The dovish elephant in the room.
The BoJ boosted bond purchases last week as part of its yield curve control policy, to defend their 10Y target and keep yields below the +0.25% limit. The policy had been introduced in 2016 to anchor rates for the economy, but is now under severe pressure as inflation is rising globally and G10-peers are hiking rates fast.
Unlimited purchases by the BoJ are causing the JPY to weaken considerably, -6% versus the USD to date already and close to USDJPY 125 last week, and appear unsustainable if bond selling pressures in the market persist. Central bank governor Kuroda is committed to YCC, and argues in favour of a weaker Yen to support the economy. A too weak Yen however, will ultimately erode support for the government and cause the Ministry of Finance to intervene, which in our view could happen around USDJPY 130. Absent of a strong risk-off shock, either the yield-curve target or the Yen must give, as both in tandem can no longer be maintained in light of higher inflation and yields globally.
Algebris Investments’ Global Credit Team
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