“Steady at 5.25%-5.5% for the fourth consecutive meeting and aligning with market expectations”

Macro

The US Federal Reserve has maintained its stance on interest rates, keeping them steady at 5.25%-5.5% for the fourth consecutive meeting and aligning with market expectations. However, the Fed’s reluctance to consider rate reductions until confident about inflation’s trajectory towards the 2% target suggests a potential pivot in the third quarter rather than the previously speculated end of the second quarter.

Market sentiment, as reflected in the futures market, indicates an anticipation of significant cuts in 2024 akin to past recessionary periods. However, the pricing of 125bps rate cuts exceeds the Fed’s median projection of 75bps and thus raises concerns about potential market disappointment.

Nevertheless, with real rates nearing 3%, the likelihood that we have approached the end of the hiking cycle is high. This transition is likely to impact investors holding money-market funds (MMF), as cash yields are closely correlated with the fed funds rate. Consequently, expected outflows from MMF funds may flow into fixed-rate bonds or alternative avenues.

As the Fed typically implements easing measures swiftly, investors may witness a rapid erosion of yield and potential returns, accentuating the importance of strategic reallocation. We recommend conservative, income-seeking investors consider reallocating funds into investment-grade bonds while yields remain historically favourable.

The asymmetrically favourable returns offered by bonds, as highlighted in a scenario analysis by Alliance Bernstein, present compelling opportunities. Despite potential inflationary pressures from geopolitical tensions, the potential for double-digit returns over a 12-month period in a rate-cut scenario, coupled with limited single-digit drawdowns in a rate-hike scenario, underscores the attractiveness of bonds.

Amid easing monetary policy and resilient growth, credit conditions are poised to stabilise, potentially limiting spread widening. The Asian region, bolstered by better export performance and attractive valuations, presents an appealing investment landscape. Quality Asian investment-grade bonds continue to offer attractive carry, providing investors with additional opportunities for yield generation.

On the FX front, investors holding dry powder may also consider vanilla simple Dual Currency Investments (DCIs) to enhance yields. In anticipation of a rate cut, the narrowing yield differentials between the US and developed markets may weaken the USD against currencies such as the Japanese Yen, Euro, British Pound, and Swiss Franc.

Furthermore, investors eyeing diversification into Japanese equities can leverage DCIs to exchange USD to JPY at advantageous rates. However, it is crucial to note that, unlike fixed deposits, DCIs entail FX risks and lack principal protection or insurance. Clients must assess their risk tolerance and be prepared to accept currency fluctuations.

In summary, amidst evolving monetary policy dynamics and market volatility, strategic reallocation into investment-grade bonds and consideration of FX instruments like DCIs can help investors navigate uncertainties while optimising returns.

Equities Strategy

In the US, the January Personal Consumption Expenditures (PCE) continued its downward trend, slightly higher than the analysts’ expectation of 3.7% year-on-year (YoY). Furthermore, the recent hawkish tone from the Federal Reserve (FED) meeting has led the market to anticipate three rate cuts starting in June.

Source: Trading view data

On the other hand, in Japan, the December core CPI remains above the Bank of Japan’s (BOJ) target of 2%, registering at 2.3%. As the core CPI is not running rampant, it suggests that the possibility of a BOJ rate hike is supported later than what the market currently expects. Markets pricing in around a 63% chance of the Bank of Japan hiking by April. This delay allows for growth in the coming quarters.

Source: CEIC, ING estimates

Source: JTUC-Rengo, “Results of spring wage negotiation final responses.”

Looking at the recent 4Q23 GDP, the Japanese economy has experienced a downturn, entering a technical recession due to sluggish domestic demand. As a result, the Bank of Japan (BoJ) is expected to exercise increased prudence in considering any policy adjustments. Provided GDP is a lagging indicator, we still expect positive growth QoQ in 2024. While we maintain the view that a rate hike in June remains a viable option, there is an increasing likelihood of a delay in mid-to-latter half of the year.

Japan is coming off its long decade of low salary raise, recently in 2022 the wage increase rate reached 2.07% followed by 3.58% in 2023. The union is currently fighting for 5% for 2024. A higher rate in 2023 and higher rate 2024 supports the GDP consumption increase in 2024.

Source: Company Filings, Bloomberg Intelligence

We hold the view given in the export-oriented economy, strong dollar against the yen, expanding share buyback programs, and growing wage rates have fueled the Japanese equity market rally. This has positively impacted and is expected to continue supporting; 1) Export-heavy names, including large multinational auto companies and manufacturers, benefiting from increased competitiveness due to a favorable yen exchange rate; 2) Consumer durable/discretionary sector, benefiting from the Shunto’s push for higher wages & benefits, leading to increased consumer spending; 3) Financial sector, poised to benefit from potential interest rate hikes in the latter half of the year since Japanese megabanks are the most sensitive among the Asia developed-market banks in terms of profit changes in response to margin adjustments. Japanese earnings range between 6% and 13% for every 5-basis-point variation in net interest margin, on average three & two times more compared to SEA & Australia respectively.