In brief

• After a 50 basis points hike by the Federal Reserve, European Central Bank, and the Bank of England, the Bank of Japan widened its yield curve control policy to plus or minus 0.50%.
• The move by the Bank of Japan aligns with hawkish messaging by other developed market central banks, and signals continued efforts by central banks to bring inflation down to their targets despite some early evidence of inflation easing.
• China’s Central Economic Work Conference indicates a pivot towards prioritizing economic growth.

Markets are busy digesting an early Christmas meal of monetary policy action and policy foreshadowing, with several central bank decisions over the past week and a half as well as the conclusion of the China Central Economic Work Conference which took place on December 15 and 16.

Baby steps towards policy tightening by the Bank of Japan

After a 50 basis points (bps) hike by the Federal Reserve (Fed), European Central Bank (ECB), and Bank of England (BoE) to their respective policy rates last week, the Bank of Japan (BoJ) surprised markets on December 20 by widening their yield curve control (YCC) tolerance band from plus or minus (+/-) 0.25% to +/- 0.50% while keeping short term rates unchanged at -0.10%.

Unsurprisingly the initial reaction to this move saw the Japanese Yen (JPY) rise 2.6% against the U.S. dollar, and the 10-year Japanese Government Bond (JGB) yields shot up to 0.43% (its highest point since 2015) at the time of writing. The sudden rise in JGB yields saw Japanese equities and fixed income come under pressure, while the Japanese bank stocks–which have been outperforming throughout this year–were given a boost.

Developed market central banks: All I want for Christmas is…for inflation to drop more

This move by the Bank of Japan falls in line with broader hawkish messaging by other developed market central banks, and signals continued efforts by central banks to bring inflation down to their targets despite some early evidence of inflation easing.

For Japan, tighter monetary policy by developed market central banks and high inflation in Japan have pressured the BoJ to review its YCC policy. Japan’s core consumer price index (CPI, all items less fresh food) has now consistently surpassed the BoJ’s 2% target over the past few months, with its latest core inflation print in October hitting 3.6% y/y. While the BoJ maintains its view that inflation is temporary and domestic demand has not recovered sufficiently to generate sustained inflation pressure, weakness in its domestic currency and lack of wage growth has led to increasing public discontent as imported inflation has significantly weakened domestic spending power. The alteration of the YCC band may take the edge off imported inflation by giving support to the JPY. The wider tolerance band can also allow the central bank to intervene less in the market. 

Exhibit 1: Inflation and central bank inflation targets

Source: FactSet, J.P. Morgan Asset Management. *The inflation figure used for Australia is based on trimmed-mean consumer price index (CPI) which is the preferred metric used by the Reserve Bank of Australia for its inflation target. **The inflation figure used for Malaysia is based on core CPI, which is the preferred metric used by the Bank Negara Malaysia (The Central Bank of Malaysia) for its inflation target. Inflation figures for other listed economies are based on headline CPI, in accordance with their preferred inflation target metric. Note that while the U.S. Federal Reserve officially targets 2% headline personal consumption expenditure (PCE) inflation, headline CPI is used for U.S. inflation in this chart due to the timelier release of data. Guide to the Markets – Asia. Data reflect most recently available as of 20/12/22.

In the U.S., the hawkish rhetoric delivered at the December Federal Open Market Committee meeting took markets by surprise, particularly after signs of headline inflation easing in November. Despite the past three months of headline CPI coming in at an annualized rate of 3.7%, Fed Chairman Jay Powell insisted that the Fed will continue to “use their tools to get inflation back to 2%”. San Francisco president Mary Daly also stressed that the Fed still has a “long way to go” before declaring victory on inflation.

While energy and core goods prices have moderated, the Fed is still waiting for a further moderation in core service shelter prices, which has proved to be stubborn over the past couple of months. As the Fed Funds futures market is still optimistically pricing in a Federal Funds Rate of under 5% at the end of 2023 at 95% probability, the hawkish messaging by the Fed has also been viewed as a ploy to counter expectations of rate cut in 2023 and to mitigate any pre-mature pick up in asset prices.

In Europe, the messaging by the ECB and BoE were even more hawkish and brought forth the differing nature of inflation between the Europe and the U.S. Eurozone and UK headline inflation came in at 10.1% y/y and 10.7% y/y in November respectively, with headline numbers in the continent proving to be more sticky than the U.S. as a result of the Russia Ukraine crisis.

ECB President Christine Lagarde pledged further 50 bps hikes heading into 2023, and stressed that the ECB had a “bigger inflation problem” than the Fed, highlighting there could be further price pressures in Europe in early 2023 as annual utility contracts are renewed. The Bank of England Monetary Policy Committee members also recommended that further rate rises in the UK were likely in order “for a sustainable return of inflation to its 2% target”.

China Central Economic Work Conference: A re-focus on growth

After a full relaxation of zero-COVD policy, priority of Chinese policy making has shifted back to economic growth. At the annual Central Economic Work Conference (CEWC), a long list of pro-growth guidelines were announced. On the front of monetary policy, the meeting advocated to use precise and effective measures to maintain feasible growth rates in credit supply and social financing.

Against the backdrop of weak consumption and investment demands, continuous monetary easing should be essential in reestablishing consumer and corporate confidence. Meanwhile, it is also necessary to maintain low financing costs to support local government financing and real estate sector. The People’s Bank of China is likely to announce further across-the-board loan prime rate and required reserve ratio cuts to lower lending costs, and meanwhile using targeted tools to facilitate financing to specific sectors such as real estate, infrastructure and small enterprise.

Investment Implications

Overall, we see a more complicated growth and monetary policy backdrop for the global economy next year. While the U.S., Europe, and potentially Japan, will tighten policy in the early parts of 2023, China is likely to maintain loose monetary policy to complement its recovery.

Growth in the U.S. and Europe will remain subpar in 2023 as their central bank’s continue to tighten monetary policy to bring down inflation at the cost of economic growth, and there will be growing debate on whether the Fed can achieve a ‘soft-landing’ in the U.S. China’s re-opening and supportive policy environment will be positive for growth in the longer run, but there remains short-term risks related to the easing of COVID restrictions.

For investors, a quality tilt within both the equities and fixed income makes sense in order to navigate through near-term uncertainty in rates and the outlook on growth. 

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