Key takeaways from the Federal Reserve and Bank of Japan’s March policy meetings

• The BOJ raised its policy rate from -0.1% to between 0% and 0.1%. It also put an end to its yield curve control policy and discontinued the purchase of ETFs and REITs.

• The BOJ’s policy pivot reinforces our view that inflation has finally returned for good, which is a positive change for a country that has struggled with deflationary pressures for nearly three decades.

• US Federal Reserve left policy rates unchanged at between 5.25% to 5.50%, raised forecast for GDP growth and core PCE.

• We believe that inflation will remain sticky, forcing the Fed to keep rates at elevated levels. Investors should focus on short duration bonds and high-quality companies.

The Bank of Japan raised its key interest rate for the first time in 17 years

The outcome of the Bank of Japan’s (BOJ) March 2024 meeting was nothing short of monumental. 

For the first time in 17 years the central bank raised its key interest rate from -0.1% to between 0% and 0.1%, officially closing the chapter on its negative interest-rate policy. Officials also said that the BOJ will put an end to its yield curve control policy and discontinue the purchase of ETFs and REITs. Lastly, the BOJ plans to gradually reduce the amount of commercial paper and corporate bonds purchases and aims to stop this practice in about a year. 

While the BOJ anticipates that “accommodative financial conditions will be maintained for the time being”, these measures undoubtedly mark a shift away from the ultra-loose monetary policy it has adopted over the years. 

According to statement by the BOJ, Tuesday’s decision was made after officials ascertained that Japan’s economy has seen a moderate recovery, and is likely to continue growing at a healthy pace. Just two weeks ago, 4Q23 GDP growth was revised up to 0.4%, vs an initial estimate for a -0.4% contraction. The increase was supported by positive contributions from exports and business spending as corporate profits improved (Figure 1). 

Figure 1: The Japanese economy continues to expand at a healthy pace

A new dawn for Japanese equities is upon us

Despite the adjustment in monetary policy, our outlook for Japan to enter an era of structural transformation and consequently for its equities perform well has not changed. 

As a matter of fact, the BOJ’s policy pivot only serves to reinforce our view that after a 25-year battle with deflation, inflation has finally returned to Japan for good. As of February 2024, Japan’s CPI came in at 2.2%, and has managed to stay above the central bank’s 2% target for 22 months in a row now. Inflation expectations are also on the rise. 

Of course, one of the key factors behind the resurgence of inflation in Japan is wage growth. As noted by the BOJ, Japan’s labour market is showing little signs of loosening, making it highly likely that wages will continue to increase steadily this year. According to Rengo (Japan’s largest labour organisation), major firms have agreed to wage hikes of approximately 5.3% in this year’s annual spring wage negotiations. This marks the largest increase in over 30 years, and it also eclipses last year’s gain of 3.6% (which was already considered good by historical standards).

Figure 2: Wages in Japan are set to rise at a record pace in 2024 

Overall, this suggests that the virtuous cycle between wages and prices has become more solid, thus increasing the likelihood that inflation can be sustained at the BOJ’s target in the long-term – which is good news for the economy. 

Higher wages encourage greater spending, which equates to higher aggregate demand, which ultimately promotes economic growth. Besides benefitting from greater demand, companies should also feel more comfortable raising prices in an inflationary environment, which should have a positive impact on margins and earnings.

Rising inflation may also motivate domestic investors to explore riskier investments (such as equities) to protect their asset values, channelling inflows into markets thus supporting equity prices in the process. Japan’s roaring stock market after decades of lacklustre returns also provides a compelling incentive for domestic investors to invest. 

All in all, we believe that investors should embrace the BOJ’s policy pivot, as it is a sign that the country’s woes with deflation is finally over. Coupled with other structural drivers such as corporate governance reforms and the country’s revival as a semiconductor powerhouse, we believe that Japanese equities have more room to run. We reiterate our 2026 target price of 48,000 for the Nikkei 225 Index. 

As for the JPY, while it has fallen against the USD in the wake of the BOJ’s decision to raise rates, we still expect it to be one of the top performing currencies in 2024. The greater likelihood for more interest rate hikes and higher JGB yields means that the yield differentials are going to narrow, which should result in an appreciation of the JPY. 

Investors who wish to take advantage of this should consider products with an unhedged share class. Our recommended products to gain access to Japan’s equity market are the Eastspring Investments - Japan Dynamic AS SGD and the iShares MSCI Japan ETF (NYSE:EWJ).

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Japanese Yen will be one of the top performing currencies in 2024  

Fed holds interest rates steady, raises forecast for GDP and inflation

Turning our attention to the US, the Federal Reserve concluded its second policy meeting of the year on Wednesday, where it left the Fed Funds Rate unchanged at between 5.25% to 5.50% for the fifth consecutive time. In addition, the committee said that it will continue to reduce the size of its balance sheet as described in its previously announced plans.

More importantly the Fed also updated its summary of economic projections, where they made significant upward revisions to their estimates for GDP growth and core PCE – from 1.4% to 2.1% and 2.4% to 2.6% respectively. What is bizarre is that they did not make any changes to their policy rate forecast, continuing to signal three rate cuts by the end of this year as they did back in December 2023. 

Table 1: Summary of economic projections March 2024 vs Dec 2023

The Fed is unlikely to cut interest rates this year

We find the Fed’s projections on the path of monetary policy inconsistent with their outlook for stronger economic growth and higher inflation. This, along with the slew of better-than-expected economic data in recent times reinforces our view that the US economy is doing well, and there is no need for the Fed to cut rates this year. 

Even though inflation has come down from its 2022 highs, we believe that it still has a long way to go before reaching the Fed’s target. As we have previously stated, inflation never follows a linear pattern, and it will become harder to fight the more it slows. The past three months of hotter than expected CPI data proves this point. Consumer prices rose 3.2% in February, beating estimates of a 3.1% gain driven by higher shelter and food prices (Figure 3). 

Figure 3: CPI has surprised on the upside for three straight months 

While the Fed has not made any adjustments to its policy rate forecast, markets have. As of 22 March, investors are now pricing in three rate cuts this year, a drastic change from six rate cuts at the beginning of the year. Even though investors have tempered their expectations, we still think that they are overly optimistic for the reasons mentioned above. We reaffirm our view for no rate cuts this year, and for interest rates to stay higher for longer. 

Given our expectation that inflation and interest rates will stay higher for longer, investors should consider investing in short duration bonds and high-quality companies. 

Table 2: Recommended products to consider 

Related Article: The Fed will not cut rates this year. Here’s why.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities. The analyst who produced this report holds a NIL position in the abovementioned securities.