BNP AM

The sustainable investor for a changing world

BLOG, , | Blog - 5 Min

Weekly market update – An upbeat start to 2023

Financial markets have begun 2023 with a spring in their step. US inflation data has been interpreted positively. Bond yields have fallen and stocks have rallied. The focus is shifting from inflation to economic growth, with hopes of a softer landing than previously expected. In our view, however, the vanquishing of inflationary pressures in the US economy will not be as straightforward as many in the markets now anticipate.  

BoJ confounds markets

At its meeting on 18 January, the Bank of Japan (BoJ) resisted market pressure and left its yield curve control measures unchanged, weakening the yen and pushing Japanese stock valuations higher as it maintained a core pillar of its ultra-loose monetary policy.

There has been considerable pressure on the BoJ to end Japan’s two-decade experiment in massive monetary easing. This week, governor Kuroda insisted yield controls were sustainable. The decision follows weeks of turmoil in the Japanese government bond market during which yields have surged.

The BoJ has deployed the equivalent of about 6% of Japan’s gross domestic product over the past month on buying bonds to try to hold yields within its target range. This week’s decision not to change either its policy or forward guidance is likely to prolong this struggle with the market.

In December, the BoJ unexpectedly decided to allow a higher target yield ceiling on 10-year government debt — permitting yields to fluctuate by 0.5% above or below its target of zero. This raised the prospect of a historic pivot by the last of the G3 central banks still adhering to an ultra-loose monetary regime. Scrapping the cap on yields would in effect push up interest rates, at least for longer-term government debt. Instead, the BoJ made no further changes to its yield curve control (YCC) policy, sticking to the range set in December.

Governor Kuroda, who will step down in April after a record 10 years at the helm of the BoJ, said last month that changes to the YCC limits were meant to improve bond market functioning and were not an ‘exit strategy’. Since the policy meeting on 20 December, 10-year government bond yields have continued to rise, to above 0.5%. This has prompted markets to pressure the central bank to abandon the yield target altogether.

In the wake of the latest BoJ’s meeting, our multi-asset investment team has initiated an overweight position in the Japanese yen versus the euro. They see the euro/Japanese yen exchange rate near the top of its trading range of recent years with the yen also attractively valued on a longer-term basis. The euro, in contrast, appears to be priced for an unrealistically positive scenario this year (e.g. economic strength and a problem-free resolution of the energy crisis).

US Treasury borrowing limit in sight

US Treasury Secretary Janet Yellen warned Congress last week that she expected the debt ceiling to be hit on 19 January. The Treasury can resort to so-called extraordinary measures to fund itself and avoid a technical default at least until early June. This gives policymakers in the House of Representatives time to negotiate an agreement to raise the ceiling.

However, the political gamesmanship witnessed in the recent House leadership election suggests there is little appetite for compromise. Once the extraordinary measures take effect, the Treasury will continue to make room to issue T-bills and boost its Treasury General Account balance as the ‘X-date’ approaches, cheapening T-bills further and potentially tightening short-end spreads.

US inflation falls again

US inflation fell in December to its lowest in more than a year, in a further sign that the peak in price pressures is in the past. The rate of increase in the headline consumer price index (CPI), published on 12 January, declined for a sixth consecutive month, leaving the annual increase at 6.5%.

While still near a multi-decade high, this was its lowest since October 2021 and represents a significant fall from the 9.1% reached in June 2022. Compared with the previous month, prices dropped by 0.1%. The core measure, excluding volatile food and energy prices and regarded as a more reliable indicator of inflation’s trajectory, rose by 0.3% from the previous month, translating into a 5.7% annual pace.

We expect the core measure to fall more slowly than the market anticipates due to the continued strength of the US labour market translating into pressure for higher wages.

Although the headline and core CPI data was in line with expectations, markets have turned away from the nuances of the data to focus more on the overall broad disinflation taking place in consumer prices.

On account of the fall in headline inflation, the market is pricing less than 50bp of US rate rises between now and the Federal Reserve’s March policy meeting, implying a potential pause in the tightening cycle in March. With a likely further downshift to 25bp rate rises before pausing, market participants appear to be looking through the end of monetary tightening and focusing on the depth of a potential recession.

Our macroeconomic research team still expects the Fed to raise rates by a further 75bp in 2023 (50bp in February and 25bp in March).

Our view is that core inflation will be slower to fall than currently priced by markets. For this reason, we expect the Fed to raise and then hold policy rates at above 5% throughout 2023 rather than lower them, as priced by markets, later this year.

Weaker US economic data

Despite the more upbeat interpretation by the market of the outlook for inflation, US economic survey data have continued to look weak. This week, the Philly Fed survey will follow the Empire State survey in providing a first look at business conditions in the manufacturing sector at the start of the year. The Empire State Manufacturing survey signalled a contraction, with a reading of -32.9.

In foreign exchange markets, the US dollar touched a seven-month low on 18 January, continuing the reversal of the rising trend that dominated much of 2022. The dollar’s fall is one of the steepest since the global financial crisis. This week’s drop came as US retail sales figures showed a 1.1% year-on-year drop in December — a bigger-than-expected fall.

Moreover, industrial production data may add to weak factory signals. Industrial output is expected to have dropped for a third straight month in December, adding to signs of deterioration including disappointing data from the Institute of Supply Managers (ISM) and a slide in manufacturing hours worked in the recent jobs report.

On the sunny side of the street

Markets, however, have continued to trade in risk-on mode. Sentiment has improved amid short-covering in stock markets, with futures net positioning falling to below half of peak short levels. Part of the rally was driven by a repricing of central bank hawkishness as investors were reassured by the latest US CPI report. As a result, bond yields have trended lower and duration-sensitive sectors have outperformed.

Moreover, European equities have outshone their US counterparts as investors anticipate that softer energy prices and a reopening of China will blunt the global economic slowdown expected for this year.

The minutes of December’s ECB policy meeting will be in focus this week. The tone of the meeting was hawkish despite policymakers agreeing to a downshift in the tightening cycle to 50bp, so we would expect the minutes to reflect this. The language introduced at the time (“interest rates will still have to rise significantly at a steady pace”) suggested more rate rises to come.

Our macroeconomic research team is maintaining its forecast for a 3.50% terminal rate. The market is pricing a terminal rate of 3.3% (which is down by 15bp since the start of the year). One key aspect of the minutes that markets will be monitoring is the degree of adherence or otherwise by the ECB to this hawkish language, and any nuances in the discussion, including how contingent on inflation it is.

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, (the Sub-Fund's) performance may at times be better or worse than the performance of relatable funds that do not apply such standards.

Related insights

8:43 MIN
What to look for when allocating assets in 2023
Daniel Morris
2 Authors - Blog
Weekly market update – False alarm?
BNPPAM

In the U.S., this material is for Institutional use only – not for public distribution. This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Reliance upon information in this material is at the sole risk and discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any investor.

These documents and video clips may also include information obtained from affiliated investment management companies within BNP Paribas Asset Management, the brand name of the BNP Paribas group’s asset management services. The documents and video clips are produced for informational purposes only and do not constitute: 1. an offer to buy nor a solicitation to sell, nor shall they form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Any opinions included in these documents and video clips constitute the judgment of the author/ presenter at the time specified and may be subject to change without notice.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, and estimates of yields or returns. No representation is made that any performance presented will be achieved by any funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or any historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BNP PARIBAS ASSET MANAGEMENT USA, Inc. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

FOR INSTITUTIONAL AND FINANCIAL PROFESSIONAL INVESTOR USE ONLY. THIS MATERIAL IS NOT TO BE REPRODUCED OR DISTRIBUTED TO PERSONS OTHER THAN THE RECIPIENT.

BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended. BNP PARIBAS ASSET MANAGEMENT USA, Inc. is a registered trademark of BNP Paribas or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP PARIBAS ASSET MANAGEMENT is the global brand name of the BNP Paribas group’s asset management services. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP Paribas Asset Management seeks to integrate environmental, social and governance (“ESG”) factors into all of our portfolios as a means to mitigate certain short, medium and long-term financial risks, identify better long-term investments, and encourage more responsible corporate behavior. We will never subordinate our client’s interests to unrelated objectives. Certain issuers and industries are excluded from our actively managed portfolios based upon our view of their ESG performance and risk profile. As a result, we may pass up certain opportunities when these excluded issuers or industries are in favor. Due to significant gaps in disclosure regimes around the world, we may need to rely upon voluntary disclosures by issuers, which are often not audited. We therefore may not have consistent access to complete, accurate or comparable information about the ESG performance of our holdings. Please consult the applicable offering document for more information about the specific ESG strategy employed by each investment strategy since a given strategy may not have specific ESG guidelines, and investments are not limited to securities that are ESG compatible.

To access insights from our teams worldwide visit:
BNP AM
Explore VIEWPOINT today