While USD/JPY can spike lower in times of extreme risk aversion – as it did in March during the height of the financial crisis – it cannot stay below 100 for long, in my view. The main reasons are that (i) there are relative few JPY assets that foreigners might be willing to warehouse for a sustained period; and (ii) Japanese investors themselves, led by some institutional funds, will likely continue to diversify out of the JPY market. This note is about one particular aspect of the latter, that Japan’s Government Pension Investment Fund (GPIF) – Japan’s sovereign pension fund, with AUM of US$1.5 trillion – will almost certainly be restructured after the eight-year divestment programme is complete by end-FY2008/09. Thereafter, more divestment from JGBs and diversification into foreign assets will be likely, in my opinion. The recent proposal by the Council on Economics and Fiscal Policy (CEFP) to reform the GPIF is important, and investors should pay attention to developments in this space. This matter may also be related to the SWF (sovereign wealth fund) discussion in Japan, whereby the prospective SWF may become the main investment vehicle for the GPIF.
Stephen Roach, Head Economist, Morgan Stanley
Japan: US$1.5 Trillion GPIF Reform and Outflows from Japan
While USD/JPY can spike lower in times of extreme risk aversion – as it did in March during the height of the financial crisis – it cannot stay below 100 for long, in my view. The main reasons are that (i) there are relative few JPY assets that foreigners might be willing to warehouse for a sustained period; and (ii) Japanese investors themselves, led by some institutional funds, will likely continue to diversify out of the JPY market. This note is about one particular aspect of the latter, that Japan’s Government Pension Investment Fund (GPIF) – Japan’s sovereign pension fund, with AUM of US$1.5 trillion – will almost certainly be restructured after the eight-year divestment programme is complete by end-FY2008/09. Thereafter, more divestment from JGBs and diversification into foreign assets will be likely, in my opinion. The recent proposal by the Council on Economics and Fiscal Policy (CEFP) to reform the GPIF is important, and investors should pay attention to developments in this space. This matter may also be related to the SWF (sovereign wealth fund) discussion in Japan, whereby the prospective SWF may become the main investment vehicle for the GPIF. Full Story Will the Next Move From the Bank of England Really be a Hike? Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank Over the last two months we have seen a massive re-pricing of monetary policy globally - and not least in the UK. The market has gone from pricing the Base rate to be reduced by approx. 100bp to 4% next year, to now pricing close to a 50bp hike over the next year. What has changed so much? First of all the easing of the financial crisis has led to a move out of safe government bonds but, more recently, the inflation scare has really taken hold in the market. This has been driven by the move higher in oil prices and a rise in inflation expectations. Inflation data also surprised strongly to the upside, jumping to 3.0% in April from 2.5%. Finally, the Inflation Report released on 14 May pointed to upside inflation risks, and was read as a sign that the Bank of England was no longer able to underpin growth by cutting rates further. Full Story Fed On Hold: Steeper Yield Curve E. Silvia, Ph.D. Chief Economist, Wachovia
Full Story
Will the Next Move From the Bank of England Really be a Hike?
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
Over the last two months we have seen a massive re-pricing of monetary policy globally - and not least in the UK. The market has gone from pricing the Base rate to be reduced by approx. 100bp to 4% next year, to now pricing close to a 50bp hike over the next year. What has changed so much? First of all the easing of the financial crisis has led to a move out of safe government bonds but, more recently, the inflation scare has really taken hold in the market. This has been driven by the move higher in oil prices and a rise in inflation expectations. Inflation data also surprised strongly to the upside, jumping to 3.0% in April from 2.5%. Finally, the Inflation Report released on 14 May pointed to upside inflation risks, and was read as a sign that the Bank of England was no longer able to underpin growth by cutting rates further.
Fed On Hold: Steeper Yield Curve
E. Silvia, Ph.D. Chief Economist, Wachovia
Over the next few meetings we expect that the Fed will remain on hold and thereby keep short rates anchored. At the longer end of the curve, the outlook is for a gradual rise in rates as inflation remains a persistent issue while recession fears dwindle. For the Fed, the dual mandate on growth and inflation suggests no change in policy at the June and August meetings. Growth remains disappointing for sure but not so weak as to prompt the Fed to ease again. Net exports and government spending provide just enough spark to keep the economy growing through the second quarter. Looking ahead the Fed, as do we, wait to see the impact of the federal rebates and higher gas prices on consumer spending in the summer. Inflation, meanwhile, remains above the Fed’s perceived tolerance range. This limits the Fed’s ability to ease in the near term as long-run inflation concerns revolve around higher inflation expectations sentiment in consumer surveys.
Rude Crude
Steve Chan, Economist, TD Bank Financial Group
Of course, regardless of where you live, high oil prices are weighing on the shoulders of consumers and the profit margins of businesses. At first blush, it would seem oil prices have detached from reality. To be sure, in the past, a U.S. slowdown would have been sufficient to bring down oil prices. In the current state of the global economy, however, a U.S. slowdown is a necessary piece of the puzzle, but it is no longer sufficient. Oil demand from the U.S. has fallen by over 200k barrels per day (bpd) over the last year and by nearly 300k bpd across other advanced nations. However, over this same period, we have seen an increase in demand from emerging markets (EMs) of 1,100k bpd. Overall, this has led to a 1% increase in global oil demand over the last year. Until we see a broad deceleration in EM demand – which is likely in the second half of the year – we are likely to continue to see pressures on oil prices. Especially given that the price of crude in many EMs remains subsidized by appreciating local currencies and government price controls.
UK Inflation Expectations Take-Off Makes Cutting Rates Difficult
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
A worrying aspect of the recent rise in actual inflation in the UK has been the accompanying rise in inflation expectations. Expectations matter for actual inflation. The reason is twofold; first, if companies believe that inflation is likely to remain high, they are more willing to raise their prices and to pay workers more. Second, if consumers believe that inflation will remain high they are more likely to accept price rises and to push for higher wages to compensate them for a loss of real purchasing power. A sharp rise in price inflation has destructive economic effects; it makes companies less likely to invest, as they demand a higher rate of future profit growth (to compensate for inflation) to justify investing today. This means weaker economic growth, resulting from weaker employment and higher unemployment. Moreover, those on fixed incomes are likely to suffer more, as they are unable keep up with inflation eroding their real income, so poverty levels are likely to rise and put upward pressure on public spending.
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