TOKYO — For the Bank of Japan and US Federal Reserve, what a difference a week makes.
As 2023 ended, the BOJ was almost universally seen as “tapering” on the way to exiting quantitative easing (QE). Governor Kazuo Ueda’s team was viewed as setting the stage for a pivot that would send the yen skyrocketing.
Markets were convinced, too, that Fed Chairman Jerome Powell would be easing three times or more this year. Perhaps more as inflation pressures recede thanks to the highest US yields in 17 years undermining gross domestic product (GDP).
These rather pragmatic predictions have collided head-on with 2024. First came a 7.6 magnitude earthquake that further shook confidence in Japan’s government and economic outlook.
Then, four days later, came news that the US added a greater-than-expected 216,000 non-farm payroll jobs in December. It capped off a buoyant year for the US labor market and rapidly altered expectations for Fed rate cuts.
This U-turn in economic reality has the yen falling rather than rallying. And it’s delaying, at least for now, any plunge in the US. As these most crowded late 2023 trades go awry, Asia is reappraising economic trajectories.
For one thing, if the Fed fails to lower borrowing costs with the haste investors hope, Asian markets could give up gains driven by those very expectations.
In December, emerging markets from Jakarta to Sao Paulo enjoyed confidence-boosting rallies on hints by the Fed that US rate cuts are imminent. In Tokyo, the Nikkei Stock Average’s recent return to 33-year highs was predicated in part on anticipated powerful Fed rates to come.
Expectations for a big Fed pivot also had officials in Beijing breathing easier. Last month, Chinese leader Xi Jinping looked forward to a period when his team could address a property crisis, deflationary pressures and record youth unemployment without headwinds from Fed headquarters in Washington.
But are Asian markets sufficiently positioned for the likely disappointments to come? Odds are they’re not.
“Solid employment gains, low unemployment and sticky wages suggest no immediate need for Federal Reserve rate cuts,” says economist James Knightley at ING Bank.
This argument, though, is being made even before the real spoilers that could confound bond markets and, by extension, equity valuations as 2024 unfolds.
One is surprisingly robust US labor conditions adding upward pressure on wages. The December jobs data showed the extent to which wage gains are outpacing inflation.
Average US hourly earnings rose 4.1% over the past year compared with a 3.1% national inflation rate. The risk is that this dynamic blows up today’s investor optimism about a “soft landing” in the globe’s biggest economy.
As economist Mark Zandi at Moody’s Analytics points out, Americans’ real purchasing power is improving, and consistently so. This, he argues, is having a lagging effect on overall confidence.
In the post-Covid-19 period in 2021 and 2022, US households “got creamed” as inflation outpaced wages, Zandi notes. That shock, he says, explains why many are still “so uncomfortable with their financial position.” Now, he adds, things are “improving very quickly as wage growth remains strong.”
This dynamic may give the Fed pause as the world’s most-watched central bank mulls an about-face in policy. Hitting the monetary accelerator prematurely would squander the effects of the most aggressive Fed tightening since the mid-1990s.
As such, says strategist Matthew Ryan at global financial services firm Ebury, “we stand by our stance that calls for a first US rate cut in March are premature and that the Fed will need to see more evidence of a cooling in the jobs market, particularly in wages, to have confidence in achieving its medium-term inflation objective.”
George Mateyo, chief investment officer at Key Private Bank, concurs. The US, he says, “closed out the year on a high note, with stronger than expected labor market trends,” meaning the Fed maintains a “higher for longer” crouch for the foreseeable future.
Mateyo’s bottom line: Those “who thought the Fed will be aggressively cutting rates in 2024 will need to walk back their forecasts.”
The view, of course, isn’t universal. Kelvin Wong, an analyst at OANDA, points to hints in recent data that 11 Fed rate hikes in less than 20 months are having a cumulatively negative effect on US growth.
“Overall,” Wong says, “the mixed US jobs report for December has indicated the prior US Federal Reserve’s interest rate hike cycle has started to inflict some adverse impact on the labor market, which in turn keeps the expectation of a Fed dovish pivot alive in 2024.”
Tom Orlik, global chief economist at Bloomberg Economics, adds that “central banks are looking forward to a victory lap as inflation tracks back to target with only a modest blow to growth. Markets cheering the policy pivot will provide the appropriate soundtrack.”
Yet the plot for such debates thickens when considering the geopolitical hellscape that might lie ahead in 2024.
The number of flashpoints that could boost energy and food prices anew is increasing by the day. Top risks include Russia intensifying attacks in Ukraine, Saudi Arabia’s determination to slash oil production among OPEC+ members and the Israel-Hamas war widening into a full-blown regional catastrophe.
News in late 2023 that the US military responded to attacks by Iran-backed Houthi militants by sinking a number of ships raised the stakes for a wider Middle East conflagration. Any extended disruption in shipping patterns near the Suez Canal would have central banks everywhere rethinking inflation risks.
Not surprisingly, the Middle East stands among Ian Bremmer’s top global risks for 2024.
“All these pathways pose risks to the global economy,” warns Bremmer, CEO of the Eurasia Group political risk advisory. “Most of the world’s largest shipping companies have already suspended transit through the Red Sea in response to the Houthi strikes, paralyzing a critical waterway that sees 12% of global trade pass through it.”
Bremmer adds that “ongoing Houthi attacks will keep freight insurance rates elevated, disrupt global supply chains and create inflationary pressure. In addition, the closer the conflict comes to Iran, the greater the risk of disruptions to oil flows in both the Red Sea and the Persian Gulf, pushing crude prices higher.”
At the same time, Bremmer notes, any moves by Israel, the US or others to block Iran’s 1.4 million barrels per day of oil exports via sanctions or military strikes “would provoke retaliation by Tehran that puts larger volumes of oil and LNG exports from the region at risk.”
Even if this worst-case scenario, a closure of the Strait of Hormuz, remains a “very low probability,” Bremmer says, the mere specter could spook investors.
All this is complicating the BOJ’s 2024, and fast. After taking the BOJ reins last April, Governor Ueda passed up numerous opportunities to signal an end to 23 years of QE.
There were several moments in 2023 when global markets — and, grudgingly, Tokyo’s political establishment — were primed for a BOJ shift away from ultraloose monetary stimulus. Ueda demurred, opting instead for only technical tweaks.
There’s been a question for years about how ready Japan Inc was for an end to the free-money gravy train. In 2013, Ueda’s predecessor Haruhiko Kuroda was hired to expand a QE program first introduced in 2001.
Kuroda acted fast to grow the BOJ’s balance sheet. His team cornered the government bond market and became the biggest investor in Japanese stocks, topping the gigantic US$1.6 trillion Government Pension Investment Fund.
Such largesse, though, has a way of warping a financial system. Over time, trading in Japanese government bonds (JGBs) all but seized up. There have been countless days in recent years when not a single debt issue traded in the secondary market.
Thus when the highest inflation in 40 years arrived in 2022, JGB yields didn’t spike the way they did in the US and Europe. One reason: the unusually high percentage of bonds held by banks, companies, local governments, pension and insurance funds, universities, endowments, the postal savings system and retirees reduces incentives to sell.
In December 2022, Kuroda tiptoed up to signaling a move away from QE by letting 10-year yields rise as high as 0.5%. It shook global markets and sent the yen skyrocketing. That prompted Kuroda’s BOJ to increase bond purchases to communicate that QE wasn’t going away.
Ueda read from the same playbook in 2023 as he moved to let 10-year yields top 0.5% and then 1%. Both times, the BOJ scrambled immediately after to intervene in markets to avoid a jump in JGB rates. Absent, though, are concrete signs that Ueda sees room to begin wrapping up QE in 2024.
Reports this week that Tokyo inflation slowed for a second month in December, a sign that cost-push inflation is easing, gives Ueda cause to stand pat. Last week’s earthquake, which killed 168, adds to the reasons why Ueda might not act.
So is the high likelihood that Japan ended 2023 in recession. And with Prime Minister Fumio Kishida’s approval rating at 17%, will Ueda think now is the time for a revolutionary change in the BOJ’s stance?
“We continue to expect that the timing of elimination of the negative interest rate policy is close, though uncertainty related to the earthquake has risen,” says Takeshi Yamaguchi, chief Japan economist at Morgan Stanley MUFG.
Economist Daisuke Karakama at Mizuho Bank thinks that the BOJ stepping away from negative rates in the first half 2024 has “become doubtful.”
So has virtually everything markets thought they knew about Asia’s 2024 and where the BOJ and Fed would be taking global interest rates.
Follow William Pesek on X, formerly Twitter, at @WilliamPesek