Weaker economic activity has raised hopes for more moderate US rate hikes

We have reached a stage when investors in US stock market have begun to view weaker economic activity as potentially positive as hopes are that early indications of slowing employment growth will weaken Federal Reserve’s resolve in hiking rates too aggressively. This has led to falling long term rates while US stocks staged a notable bounce last week led mainly by technology names with S&P closing over 9% above its recent lows while tech heavy Nasdaq finishing 10% above its previous week’s trough. 

Indeed, what seems increasingly evident is that falling valuations of IPOs and generally tougher financing environment has led to weaker hirings among start-ups and increasing lay-offs among gig economy firms. However, with post-pandemic travel and leisure segments of the economy currently booming, we suspect rising inflationary pressures within the more traditional parts of the service sector are likely to become more problematic for Western central banks.

Focusing on our own market in Japan, lower US long term rates tend to be viewed more negatively given the high cyclical nature of the stock market. Indeed, market activity has remained fairly subdued with Topix index remaining range bound while the smaller caps Mothers gauge which usually provides a good pulse in terms of reflecting confidence for the overall stock market direction is trading close to its recent lows and more than 45% below its November 2021 peak.

Recent easing of US long bond yields and lower than expected inflation gauge in Japan has given BOJ some breathing room to maintain its zero-interest rate policy as the yen has recouped some of its big losses against the US dollar. However, as we have previously noted, we don’t believe stronger yen is sustainable given that most other major central banks look to follow the Federal Reserve by hiking interested rates towards a more neutral monetary policy stance to fight off inflationary pressures.

Indeed, yen’s recent weakness against the euro underlines that sentiment regarding the Japanese currency remains fairly weak. Moreover, with energy prices surging once again as concerns are growing that Russia could cut off Europe from its gas supplies, we don’t believe we have passed the peak in input costs, especially in yen terms.