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• Equities gained in sterling terms across the UK, Europe and emerging markets
• Bonds edged higher, with gilts up +0.2% on the week

• Japanese equities softened -1% in sterling terms, hindered by currency weakness of the wake of the BoJ’s policy pivot
• US equities also softened modestly, falling -0.2% on the same basis

With the Federal Reserve (Fed) in wait-and-see mode, the market is keeping a close eye on incoming data. Recent data prints have been somewhat mixed, with inflation and employment showing greater strength. Inflation has accelerated modestly over recent months and employment appeared to be strengthening in December and January, only to be revised lower in February.

Despite this, at the March Federal Open Markets Committee (FOMC) meeting, Chair Powell remained sanguine on inflation and brushed off concerns about stronger Consumer Prices Index (CPI) prints as “bumps in the road” - confirming that “the (inflation) story is really essentially the same.”

Friday’s Personal Consumption Expenditure (PCE) data likely reinforced the view that inflation could strengthen in the near term, but should decelerate later this year. February Headline PCE slowed to 0.3% month-on-month, while the January reading was revised up to 0.4%. Core PCE slowed from an upward-revised 0.5% to 0.3%. The upward revisions to January’s data reflected upgrades to medical services costs. Core goods prices also firmed, while core services softened significantly from 0.6% in January to 0.2% in February.

Looking ahead, goods prices could support inflation prints for the first quarter of this year, but the combination of softer rent prices, slowing wage growth and improved productivity data is expected to ease inflation later in the year. FOMC members will need this reassurance to begin cutting rates. In the words of Chair Powell, “the Committee needs to see more evidence to build our confidence that inflation is moving down sustainably toward our two percent goal and we don't expect that it will be appropriate to begin to reduce rates until we're more confident and that is the case".

Markets continue to expect a rate cut this summer, currently anticipated in July.

With the Bank of Japan (BoJ) beginning the process of normalising monetary policy, markets are turning to economic data to see how far normalisation can go.

In March, the BoJ voted to tighten monetary policy and end its negative interest rate policy, in place since 2016, along with its Yield Curve Control policy. However, despite tightening rates, Japanese monetary policy remains one of the easiest globally.

The market expects further rate hikes - futures are pricing in just under two 25bps increases this year, which would take the policy rate to +0.25% by December. However, question marks remain as to whether economic activity can sustain this degree of tightening.

February activity data, painted a mixed picture of the Japanese economy. Industrial output declined -0.1% in February, after a sharp -6.7% fall in January. In contrast, retail sales are showing more resilience, rising +1.5% in February, following a rise in January.

This data is representative of Japan’s economic fortunes currently. Stronger real-terms wage growth appears to have boosted confidence and thus consumption activity. While the unemployment rate did rise in February to 2.6%, this reflects an increase in the labour market participation rate.

In contrast, the manufacturing sector remains weak, likely relating to soft activity in China. This is likely to lead to a decline in Japanese GDP in the first quarter. As such, the scale of policy normalisation is likely to be modest in a global context.

China remains an important driver of global growth, and economic data remains soft this year. Business surveys, released over the weekend, point to some improvement. Both official Purchasing Managers’ Index (PMI) readings saw a rise, with both services and manufacturing sectors showing improvement, while the Caixin manufacturing PMI also registered a positive move.

However, without further policy support, Chinese activity is not expected to recover meaningfully, and growth is likely to miss the Government’s own 5% GDP target. Indeed, economists expect 4.5%, and perhaps as little as 3% without some improvement in the property sector.

Is further monetary easing and fiscal support likely? The April Politburo meeting could be a key test of this but, ironically, the fact that activity has shown a modest revival could make the chances of a large announcement more remote.

This means that disinflation could remain a risk this year, with CPI at only 0.7% in February.

 

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