Negative Rates No More

Mar. 20, 2024

The era of negative rates has ended. On Tuesday, March 19, the Bank of Japan (BOJ) raised their policy rate for the first time since 2007 by 10 bps to a range of 0 to 0.1%. The BOJ was the last major central bank to keep rates in negative territory. The BOJ also announced an end to their yield curve control (YCC) plan and ETF purchases. The decision came after inflation in Japan exceeded the 2% target for the past 18 months and as the Shunto wage negotiations led to significant pay hikes for Japanese union workers. However, policy remains incredibly loose as the BOJ did not cease their bond buying program and did not commit to a material hiking path going forward. The real policy rate (i.e., excluding inflation), remains significantly depressed relative to the rest of the world. We see scope for the BOJ to surprise on the hawkish side for the remainder of the year given sustained wage hikes and pricing pressures domestically and globally.

In the U.S., optimism for rate cuts by the Federal Reserve in the first half of this year has been tempered following a string of higher-than-expected inflation and better-than-expected job gains. Labor markets in the U.S. are softening some but outright weakness needed to bring inflation to the 2% target is still some ways off. We believe the market’s focus is shifting from when the first rate cut will occur to how many rate cuts there will be over the next 18 months. Financial conditions have loosened significantly since October, which will make the Fed’s job of getting inflation back to 2% more difficult and could shallow the path of rate cuts moving forward. Ultimately, we think the Fed could cut 2-3 times (0.25% each) in the back half of this year, which is in line with both market expectations and the latest forecasts from Fed officials. We also believe there is a chance for the Fed to proceed with more pronounced cuts into 2025 should the job market materially weaken.

In Europe, the European Central Bank has been on hold since September having raised their policy rate by 450 bps over the past two years. Inflation is coming down, though it has been disparate across the continent. Industrial economies like Germany have seen prices lower and move closer to the 2% target as labor markets tied to industrial activity have loosened. Sectors and economies tied to the services industry have seen prices remain more elevated as wages remain high and labor markets tight. The dispersion across economies highlights the difficult proposition of implementing monetary policy for 20 different countries.

Elsewhere in Europe, the Bank of England (BOE) has kept their policy rate unchanged since last summer. Inflation has been coming down for the better part of the last year but remains too high for the BOE to cut. There has been some softening in the UK housing market but not to the extent we had expected given the repricing of mortgage rates. While we believe that the next move from the BOE will likely be a rate cut rather than a hike; the timing could be further away than we originally thought due to the above mentioned factors.

Outside the major central banks, both the Bank of Canada (BOC) and Reserve Bank of Australia (RBA) are toning down recent hawkishness. Inflation in Canada is beginning to come in below expectations and could allow the BOC to be one of the first central banks to cut rates this cycle. The RBA dropped hawkish language following their recent policy meeting, deemphasizing the chance for another rate hike this cycle.

Last year we highlighted that we thought we were entering the end of monetary policy tightening globally. Japan was the outlier through the global tightening cycle and is now on the verge of playing catch up as we see scope for more tightening this year. However, outside of Japan, we have had a respite of monetary policy tightening since last summer. We now believe the global economy is on the verge of entering a period of monetary policy easing. However, the timing and depth of the easing is still unclear. Rate cuts that begin in the second half of this year would be within the historical context of 12-18 months between the last rate hike and the first rate cut. Markets typically underestimate the ascent for policy rates during the hiking cycle and also underprice the extent policy makers need to cut during an easing cycle. It would not shock us if the market again does not fully discount the depth by which policy will be cut globally over the next 12-24 months.

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This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product.

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