The Bank of Japan is Behind The Inflation Curve
A relentless rally in stocks took a breather near all-time highs, but the market still notched its best start to a presidential term since Ronald Reagan was sworn in to power in 1985.
While a rout in chipmakers weighed on trading Friday, the S&P 500 still climbed 1.7% this week. That was after President Donald Trump talked up policies to boost the economy and lower taxes, while appearing to soften his stance toward tariffs on China — even as he continued to threaten sweeping action. The dollar saw its biggest weekly drop since November 2023. The MOVE Index of expected Treasury volatility hit the lowest since about mid-December.
“It is early days, but nothing that President Donald Trump has said or done has caused a bad reaction in financial markets,” said Chris Iggo at AXA Investment Managers. “Quite the contrary. It is paying to stay invested.”
A test to that risk-on mode will be next week’s start of the big-tech earnings season. Investors are eager to see whether demand for artificial intelligence will live up to sky-high expectations. The industry was buoyed earlier in the week, with SoftBank Group Corp., OpenAI, and Oracle Corp. forming a $100 billion joint venture to fund AI infrastructure, an effort unveiled with President Trump.
The S&P 500 fell 0.3% Friday. The Nasdaq 100 slid 0.6%. The Dow Jones Industrial Average slipped 0.3%. A Bloomberg gauge of the “Magnificent Seven” megacaps dropped 0.4%. The Russell 2000 retreated 0.3%.
Among corporate highlights, Meta Platforms Inc. climbed on plans to invest as much as $65 billion on AI projects in 2025. Cryptocurrency-linked firms rallied following Trump’s executive order favoring the industry. Nvidia Corp. led losses in big tech. A disappointing forecast from Texas Instruments Inc. sent the shares down 7.5%.
In the run-up to next week’s Federal Reserve decision, bonds rose amid data showing a drop in US consumer sentiment and a slight pullback in the growth pace of business activity — though companies remained upbeat about the outlook. The yield on 10-year Treasuries declined two basis points to 4.62%. The Bloomberg Dollar Spot Index fell 0.5%.
Oil saw its first weekly drop this year, with Trump calling for lower prices, which tends to ease concerns about inflation. Russian President Vladimir Putin said he’s ready to discuss energy issues with the US president.
To David Lefkowitz at UBS Global Wealth Management, while US equities will likely be more volatile this year due to periodic concerns about the return on AI investment spending, tariffs and interest rates, any dip will likely be a buying opportunity.
“In our base case, we expect higher tariffs, but we don’t think they will rise to a level that alters the economic growth trajectory,” he noted.
Wall Street also waded through a slew of economic data on Friday, with the highlight being a drop in US consumer sentiment for the first time in six months. Consumers expect prices will climb at an annual rate of 3.2% over the next five to 10 years. They see costs rising 3.3% over the next year, the highest since May.
After cutting rates three times in late 2024, Fed Chair Jerome Powell and his colleagues are expected to hold rates steady until they see inflation make more downward progress toward their 2% target.
“Given our expectation for a somewhat uneventful Fed pause, we look for a modest Treasury market reaction unless Chair Powell surprises with a dovish press conference,” said Oscar Munoz and Gennadiy Goldberg at TD securities. “We remain long duration and expect the curve to steepen in 2025, but to remain flatter in the near-term.”
To James Egelhof at BNP Paribas Securities Corp., Powell will probably be asked about the tail risk of rate hikes at the press conference.
“We expect him to reply cautiously by indicating they are less likely, but could come into view if needed to secure a soft landing for inflation and growth,” he noted.
With uncertainty swirling around the outlook for inflation and interest rates, there’s been one dependable catalyst keeping Wall Street’s spirits lifted: Corporate America’s bottom line.
The stocks of S&P 500 members that have reported stronger-than-expected profits in the most recent quarter have outperformed the benchmark by an average of 1.5% within a day of the results, according to data compiled by Bloomberg Intelligence.
Only those that account for about one-fifth of the S&P 500’s market capitalization have so far reported. But if the trend holds, it would mark the best post-earnings reaction since 2018, the BI data show.
Corporate Highlights:
Texas Instruments Inc. shares declined the most in nearly five years after the chipmaker gave a disappointing earnings forecast for the current period, hurt by still-sluggish demand and higher manufacturing costs.
Tobacco stocks gained as a proposed ban on menthol cigarettes and flavored cigars was withdrawn by the Trump administration.
Verizon Communications Inc. reported fourth-quarter financial results that beat analysts’ estimates, including gains in new mobile-phone and broadband customers.
American Express Co. profits increased 12% as well-heeled consumers spent more than analysts expected on their credit cards over the holidays, a tailwind the firm said it expects will continue.
Boeing Co. suffered another quarter of fresh charges and losses, highlighting the long road ahead for Chief Executive Officer Kelly Ortberg as he tries to stabilize the US aircraft manufacturer.
Novo Nordisk A/S’s experimental shot delivered as much as 22% weight loss in an early-stage trial, boosting investors’ hopes for the drugmaker’s pipeline.
Alright, apart from President Trump's speech at Davos on Thursday, there wasn't anything major on the geopolitical front.
As expected, the Bank of Japan raised rates 25 basis points on Friday to its highest level in 17 years after consumer price rises accelerated in December:
The move by the Bank of Japan (BOJ) to raise its short-term policy rate to "around 0.5 per cent" comes just hours after the latest economic data showed prices rose last month at the fastest pace in 16 months.
The BOJ's last interest rate hike in July, along with a weak jobs report from the US, caught investors around the world by surprise, which triggered a stock market selloff.
The bank's governor, Kazuo Ueda, signalled this latest rate hike in advance in a bid to avoid another market shock.
According to official figures released on Friday, core consumer prices in Japan increased by 3% in December from a year earlier.
The decision marks the BOJ's first rate hike since July and came just days after Donald Trump returned to the White House.
During the election campaign Trump threatened to impose tariffs on all imports into the US, which could have an impact on exporting countries like Japan.
By raising rates now the bank will have more scope to cut rates in the future if it needs to boost the economy.
The move highlights the central bank's plans to steadily increase rates to around 1% - a level seen as neither boosting or slowing the economy.
The BOJ signalled that interest rates will continue to rise from ultra-low levels.
Neil Newman, the head of strategy at Astris Advisory Japan said: "rates will continue to rise as wages increase, inflation remains above 2% and there is some growth in the economy."
"We look for another 25-basis point hike in six months," said Stefan Angrick, a Japan economist at Moody's Analytics.
Last year, the BOJ raised the cost of borrowing for the first time since 2007 after rates had been kept down for years as the country struggled with stagnant price growth.
That hike meant that there were no longer any countries left with negative interest rates.
When negative rates are in force people have to pay to deposit money in a bank. They have been used by several countries as a way of encouraging people to spend their money rather than putting it in a bank.
WAGE HIKE
"Many firms are saying they will continue to raise wages ... Various data shows the U.S. economy is in firm shape. Markets have been stable as the broad direction of Trump's policies become clearer. While import price growth is subdued on a year-on-year basis, the weak yen is pushing up import costs."POLICY RATE
"There's no change to our view of raising our policy rate and adjusting the degree of monetary support if the economy and prices move in line with our forecasts.""The timing and pace of adjusting monetary support will depend on economic and price developments at the time. We don't have any preset idea. We will make a decision at each policy meeting by looking at economic and price developments as well as risks."SHARP UPGRADE IN INFLATION FORECASTS
"The rise in underlying inflation is moderate. I don't think we are seriously behind the curve in dealing with inflation."IMPACT OF TRUMP'S TARIFF POLICIES
"There's very high uncertainty on the scale of tariffs. Once there is more clarity, we will take that into our forecasts and reflect them in deciding policy."
"It's necessary to raise interest rates in accordance with developments in the economy and prices. We also need to see how our rate hikes affect the economy. It's therefore appropriate to gradually raise interest rates in several stages, while carefully examining the impact of our moves."TERMINAL RATE
"There's no change to our view on the neutral rate, which in our estimate is spread in a wide band. The estimated band hasn't changed much. In terms of the distance to the neutral rate, it's true it has shortened after raising rates to 0.5%. But there's still quite some distance."
"The BOJ's estimate shows the neutral rate, in nominal terms, is in a range of 1%-2.5%. There's still some distance to that range, given the short-term rate is 0.5%. Of course, we need to deepen analyses on where the neutral rate is as this could be affected by demographics and structural changes in the economy. We'll try our best. But it's hard to know this real time."ON WHETHER JAPAN IS STILL IN DEFLATION
"The government has a slightly different definition of deflation compared with ours, as we focus on sustainably achieving our 2% inflation target... In terms of the common definition of deflation, which is for an economy to avert falling prices, it seems like Japan has moved away from this quite a bit. Of course, the risk of Japan returning to deflation again in the long run is not zero. But the chance seems quite low.""The sharp rise in inflation during fiscal 2025 is mostly due to cost-push pressures expected in the first half of that year, which is likely to dissipate in the latter half. As such, if wages rise steadily, we can expect real wages to turn positive."DOWNGRADE IN POTENTIAL GROWTH ESTIMATE
"Simply put, it's because of labour shortages... The downgrade is small and so the impact, if any, on our neutral rate estimate will be minimal."ON WHETHER THE BOJ SEES 0.75% AS A BARRIER IN RAISING RATES
"We don't have any sense of a 'barrier' in mind. But when rates approach neutral or slightly exceed that level, there will be some kind of reaction to the economy such as declines in housing investment. We'll try to respond before the impact becomes very large. But we will be gradually testing the waters in finding out."
Right now, the BoJ is behind the inflation curve as real yields are deeply negative.
Higher yields in Japan are lending support to the yen which gained some ground this week but remains very weak relative to the USD which is why inflation is picking up:
This upcoming week the Fed and Bank of Canada are announcing the next policy rate move on Wednesday.
The Fed will likely hold rates steady at an unsteady moment and the Bank of Canada is widely expected to cut by 25 basis points as tariff threat looms.
Central banks add noise to the equation but it's critically important to track their latest moves and policy changes.
In the US stock market this week, the big moves I tracked were Netflix earlier this week and Twilio today following stellar earnings reports:
Both these charts are in "beast mode" and have been ripping higher, quite incredible (you buy any dip that goes to 10-week moving average).
In fact, I track a lot of stocks across the risk spectrum and so far January is all RISK ON.
What can derail this market? Higher rates and/ or a severe recession which is why you need to pay attention to central banks and any potential fallout if a trade war develops.
But to be truthful, potential higher rates worry me more than a trade war right now.
And before I forget, have a look at this chart showing US home buying conditions have collapsed to levels never seen in 65 years:
SHOCKING: Home buying conditions have collapsed to levels NEVER seen in 65 years pic.twitter.com/KfcG97eqSS
— Bravos Research (@bravosresearch) January 23, 2025
This doesn't bode well for the US economy!
Anyways, next week we get more mega cap tech earnings from Microsoft, Meta and Apple later in the week.
Below, Masahiko Loo, senior fixed income strategist at State Street Global Advisors, says there could be an interest rate hike in September.
Also, The Bank of Japan (BOJ) raised interest rates on Friday (Jan 24) to their highest since the 2008 global financial crisis and revised up its inflation forecasts, underscoring its confidence that rising wages will keep inflation stable. Economics professor Sayuri Shirai from Keio University, who is also a former BOJ board member, tells CNA’s East Asia Tonight Japan is facing a dilemma as domestic consumption is stagnant and inflation is high.
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