With global inflationary pressures building fast, we remain cautious with regard to interest rate risk in sovereign debt generally but particularly in Japan, the US and Europe. We have taken profits on part of our underweight position in Japanese government bonds (JBGs). We had just recently increased the size of the position after bond yields rose more quickly than expected in the face of sharply higher domestic prices and rising wages.
We see a shift by the Bank of Japan towards the 5-year point of the JGB yield curve (and away from the 10-year area) along with a widening of the implicit band by 25bp around its target yield as a likely next step by the central bank. At the same time, it is difficult to foresee a meaningful fall in JGB yields from the current 25bp.
Weighing up our long yen
A central bank policy shift would clearly benefit our long yen position, particularly with extreme valuations and prospective near-term triggers for the cross-rate to move in our favour. To date, however, widening interest rate differentials have weighed on the yen.
We will monitor price action closely with a view towards exiting our long yen position.
Inflation adds to pressure for rates action
Meanwhile, in Europe, the pressure on the European Central Bank (ECB) to act in response to record inflation data is mounting. Our macro research team expects higher inflation – with risks to the upside – to result in rate rises taking the policy rate to 1.75% by Q2 2023. Discount rates could easily rise above this if inflation becomes entrenched, particularly in wages.
At the same time, consensus GDP growth forecasts have fallen dramatically over the course of the year (from 1.2% to 0.2% for the second quarter, for example). Consumer confidence has collapsed. Both developments are presaging further falls in stocks.
On the ECB’s own measure, the eurozone financial system is under significant strain, akin to that experienced during the pandemic and above 2016 levels.
To date, equities, and in particular expected earnings, have been strikingly resilient given the challenging environment. We remain short Europe ex-UK equities.
Asset class views
 This is held as part of an unhedged long Topix position that has limited the recent impact of a weak yen
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