Bank of Japan tightens

The Bank of Japan (BoJ) surprised markets this week by tweaking their yield curve control (YCC) policy to widen the band of interest for their 10-year bonds (JGBs) from +/- 0.50% to 1.0%. The Bank of Japan initially lowered its interest rates post the bursting of its economic bubble in the late 80s early 90s. They have kept overnight interest rates low since, and in 2016 implemented what has become known as Yield Curve Control (YCC), which is their attempt to keep the rate of their 10 yr bonds at or near 0. All of this was done to fight deflation.

• Market participants follow what the BoJ does because a) it is one of the largest economies in the world; and b) because the BoJ has led the Western world in easy monetary policy by over a decade
• What the BoJ did was tighten monetary policy or effectively hike interest rates
• This is due to inflation expectations continuing to rise in the country for the first time in almost three decades
• The leak of the change in policy during the trading day in the US Thursday led to a steep spike in yields on longer-term US treasuries (10-30 yr)
• It also led to a reversal in the rally in stocks, with indices turning down and closing lower on the day
• The simple argument is that higher yields in Japan mean that the relatively higher yields in the US and other Western economies are not as attractive as they were before
• On the margin, this means less demand for long-term US treasuries
• Hence we saw a spike in yields and a reversal in stocks

Vibrant US economic data

This week, there was a slew of economic data in the US, which almost all indicated the economy remains strong. Except for some housing data, GDP, PMI, Consumer Confidence, Durable Goods, and Jobless Claims all came in at or better than expectations. We capped the week off with the Fed’s favored inflation indicator, PCE, which came in inline to slightly better than expected. Given this data, it is very hard to see the widely discussed recession on the horizon.

• The economy is stronger than many have anticipated at this point
• Most expected a 550bps rise in interest rates in 12 months to have a larger impact
• We believe we have not seen much of a slowdown for two reasons:
• There is still a fair amount of fiscal stimulus feeding its way into the economy at the state level
• Many borrowers (homeowners and corporates) used the low-interest rate environment to lock in low rates and have not had to tap the credit markets at these new rate levels… yet
• The longer-term problem for the Fed is as the economy remains strong and the job market very tight; it should continue to put upward pressure on wages
• Higher wages are inflationary as this causes companies to raise prices for goods and services
• This makes it more likely that the Fed will have to keep rates higher for longer (as we have discussed), however also opens up the risk that they may have to raise rates even more (if inflation re-accelerates)

Earnings surprise

Given the aforementioned economic data, it should not be a surprise that earnings should be strong, but halfway through earnings seasons and the numbers are coming in better than anticipated. 79% of companies are beating estimates by a median of 6%. Cyclicals have been a particular surprise. 84% of cyclicals are beating estimates by an average of nearly 9%. Investors will soon look forward to 2024 when earnings are expected to accelerate nearly 13%.

• This quarter is expected to be the trough in earnings
• Cyclicals and tech have had the highest beat rates
• Strong numbers from Alphabet and Meta indicate that digital advertising has bottomed. Google’s ad revenue grew 3.3%, and YouTube came in better than expected. Meta showed 11% revenue growth
• Cloud and enterprise software are showing nice growth. Google Cloud was up 28%. Microsoft Azure was up 26%. ServiceNow showed a 25% increase in subscriptions
• The semiconductor cycle could soon bottom. Intel said they expect a rebound in the year's second half. We also saw good numbers out of KLA and Lam Research
• Consumer staples continue to have pricing power. McDonald’s had nearly 12% same-store sales. Mondelez, Colgate, and Procter and Gamble also show strong pricing power
• Auto companies are reporting strong internal combustion sales, but questions remain about the EV business
• Mastercard and Visa indicate consumer spending remains healthy. Gross volume was up 12% at Mastercard. Travel and entertainment categories leading the way

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