Japan: structural change in view of inflation

In 2024, Japan is expected to see a significant improvement in economic growthsupported by a favorable combination of inflation and recovery in the manufacturing sector. We expect the Bank of Japan to end its Yield Curve Control (YCC) policy.(4)) and abandon the Negative Interest Rate Policy (NIRP(3)) in the first quarter of the year. After years marked by deflationary expectations, Japan finds itself at a pivotal moment when nominal variables are behaving in a more normal way.

1 year, 5 years and 10 years Japanese rate

Sources: Bloomberg, Richelieu Group

Economic growth has proved resilient despite weak external demand and inflation expectations are now anchored at positive levels. In response to rising domestic inflationary pressures and the depreciation of its currency, the BoJ has begun to loosen its YCC. However, he remains cautious and awaits further evidence of inflation being driven by domestic factors rather than imported cost pressures. Confidence in the wage outlook is a key indicator for the BoJ in assessing the sustainability of inflation. As other advanced economies tighten monetary policy, the BoJ hopes to take advantage of price pressures to revive the economy. There are signs that it’s working: Japan’s real wages are rising and the labor market is tight. Given Japan’s deflationary history, inflation is welcome and appears healthy so far. Spring wage negotiations in 2024 will be decisive for the future of Japan’s monetary policy. Given the current high inflation, strong corporate earnings and growing public pressure, we expect the results of these negotiations to be at least as robust as those in 2023. The BoJ should conclude in the spring of 2024 a stable inflation target with 2% in sight. Based on this, we expect NIRP and YCC to end, probably as early as January 2024, or April at the latest. These measures will not mean a tightening of policy as real interest rates will remain extremely low. We do not expect a rapid cycle of rate hikes and we do not expect quantitative tightening(1) (QT) starts before 2025. Another increase of 25 basis points is expected on the 4thThursday quarter 2024 and 2Thursday quarter 2025, bringing the Japanese rate to 0.5% by mid-2025. Japan’s fiscal policy supports this sustainable inflation. As of 2020, government spending has increased significantly, replacing emergency pandemic spending with energy subsidies and income transfers to low-income households and pensioners. With elections looming and politicians little appetite to cut spending, this trend is expected to continue and boost growth in the near term.

Japan remains a good student among developed countries. It is the only major economy whose growth will exceed its potential in 2024. Consumer spending is strong, while governance reforms adopted by the business world as a whole are helping to attract foreign capital.

This scenario of low growth slowing inflation is generally positive for assets, but the path carries many risks. For the coming months, we believe that the market can believe in a “golden bullion” state.(2)“. Access to credit could become increasingly restricted. Continued challenges in the commercial real estate market and rising bank funding costs are likely to result in reduced access and more expensive financing for consumers and businesses who can still obtain credit.

Bank loans provided to businesses and banks

The risks of slippage are numerous, whether political, geopolitical, economic, inflationary or financial.

Political risk : in 2024 we have elections in more than 20 countries, including the United States, representing more than 60% of global GDP. With the rise of populism and polarization, we expect volatility associated with the political cycle. Geopolitics are increasingly complex and pose inflationary risks to oil prices, with Europe particularly exposed.

The second major risk to the US economy is continued political dysfunction. While Congress avoided a government shutdown and, more importantly, insolvency by raising the debt ceiling through January 2025, continued economic stagnation combined with high immigration caused by wars in neighboring regions could lead to increased support for extremist political parties. parties. Finally, the 2024 US election could be a geopolitical turning point as further aid to Ukraine hangs in the balance, as does foreign policy predictability and the rule of law.

Geopolitical risk : by 2024, three hot spots should remain the focus: Russia-Ukraine, Israel-Hamas and China-Taiwan. The conflict between Russia and Ukraine has already shown that it can disrupt global markets and is expected to continue until 2024 as the Ukrainian counter-offensive appears to be coming to an end due to the winter approach and concerns about the reliability of Western funding and artillery. The conflict between Israel and Hamas is already a human tragedy, but to this day the conflict has not spread further. Expansion involving states like Iran could escalate into a regional conflict with global economic and military consequences. The most significant geopolitical tension at the economic level is connected with China.

Taiwan Status Survey (Chengchi University)

Source: Chengchi University

Disagreements between China and the West are multifaceted, with Taiwan as the short-term focal point. The elections in Taiwan in early 2024 will be the compass in the China Sea for the whole year.

Economic risk : An overheating US economy may further tighten global financial conditions, leading to a hard landing in the United States. Fiscal excesses in advanced countries pose a pro-inflationary risk to global real interest rates. Chinese policymakers may fail to stabilize expectations.

The public sector has the weakest balance sheet. Massive increases in public debt and persistent budget deficits are putting pressure on real interest rates and crowding out private investment. Debt dynamics are not sustainable at the current level of interest rates unless there is significant fiscal consolidation in the future.

Inflation risk : in the short term, disinflation planned for several months, a new shock, premature accommodative monetary policy, could create the conditions for another inflationary wave. In general, the easiest job is being done: raising inflation from 8% to 9% to 3% to 4% because benchmarks are at work. Moving from 3% to 4% to 1.5% to 2% will certainly be more difficult. It is also the fear of entering the stop-and-go spiral of the 1970s that failed before the arrival of Paul Volcker. The conclusion of these two experiments seems obvious to us: central banks must increase their interest rates to a fairly restrictive level and at the same time to a level that does not force them to lower them in the event of a crisis. The episode of regional banks and the bankruptcy of SVB and a couple of sisters proved to be a good test. The Fed can act quickly and firmly, but it won’t change its strategy.

The Fed’s Balance Sheet and Rates

Sources: Bloomberg, Richelieu Group

So we will have to wait some time before we are sure that inflation is under control, or even wait until the risks of deflation come back to the fore.

We approach the beginning of the year with greater economic confidence. So let’s take advantage of the times when the stars are aligned and the market believes it, but let’s remain attentive and alert to the paradigm shifts caused by the surprises that we are sure will come this year in 2024.

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