Charts of the Week: Bearish JPY, Short CNH, and Fading the UK Inflation Beat

Summary

• Two factors support our bullish USD/JPY call: weak Q1 seasonals for JPY, and Japan’s cyclical downturn.
• China faces a supply-demand imbalance preventing inflation from returning to positive territory.
• UK inflation remains below BoE forecasts despite the recent beat.
• Equities are trading at historically high P/E valuations, which could depress returns in 2024.

Market Implications

• We think USD/JPY could rise to 150 in coming weeks.
• Chinese deflation is one reason we are short CNH vs a basket.
• We would fade any hawkish reaction to the UK inflation beat.
• We think the Russell 2000 rally has run its course but still like it as a medium-term hold.

Two Bearish Factors for JPY in Q1

We are bullish USD/JPY and see the pair hitting 150 in coming weeks. On the JPY side, we see two bearish factors. First is that since 1980, Q1 seasonals for the yen have been poor (Chart 1). Second is that Japan’s cycle is turning down: its inflation pulse is falling, and growth surprises are off their highs (Chart 2).

Chinese Deflation Becoming Entrenched

China faces a supply-demand imbalance that is preventing inflation from returning to positive territory. Demand-side measures like easing rules on the property sector have failed to lift consumer demand, while the supply-side push for the ‘three new industries’ (EVs, batteries and renewables) and infrastructure investment has been more effective. This has left PPI at -3% YoY, the lowest level since 2016 (Chart 3). That is just one reason we are short CNH vs a basket.

UK Inflation Still Below BoE Forecasts Despite Beat

UK headline inflation rose to +4.0% YoY in December, 0.2ppt above consensus. Much of the rise came from core – the YoY rose to 5.1%, 0.2ppt above consensus and in line with Henry’s estimate, something he warned of since the last release. Our analyst-based forecast also flagged upside risks. However, we do not see it as overly hawkish. Importantly, inflation is still undershooting BoE November MPR forecasts (Chart 4). Henry sees value fading any knee-jerk hawkish reaction.

High P/E Valuations Could Depress Returns in 2024

That equities are already trading at historically high P/E valuations could hurt 2024 returns (Chart 5). Investors are pricing in a veritable Goldilocks outlook of robust earnings and rate cuts. If they face disappointment on either of these fronts, valuations will likely downshift. The super-charged rally in the Russell 2000 (or ETF IWM) has probably run its course for now, but we still like it as a medium-term hold.

Matthew Tibble is Commissioning Editor at Macro Hive. He has worked as an editorial consultant and freelance editor for companies such as RiskThinking.AI, JDI Research, and FutureScape248.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)