UNITED STATES: NEUTRAL
We maintain a neutral stance on US interest rates, as the market no longer prices in Fed cuts during the year, a position that appears reasonable given the inflationary pressures stemming from rising energy prices caused by the war in Iran. Looking ahead, the risk balance should become more symmetrical: the end of the conflict or an economic growth shock could push rates down, while persistent inflationary pressures, especially if energy prices rise further, could push them up.
CHINA: NEUTRAL
We maintain a neutral stance on onshore Chinese rates but expect a relatively flatter yield curve in the coming months. Inflation expectations among households and local investors are likely to strengthen further, following the rise in oil and gas prices, and the international market has recently begun to scale back its expectations regarding the timing of rate cuts. Since the end of last year, we anticipate a recovery in price levels and a more restrained monetary policy compared to market expectations.
JAPAN: UNDERWEIGHT
The Bank of Japan (BoJ) kept interest rates unchanged at 0.75% in the April meeting, as widely expected. However, the decision can be described as a “restrictive pause.” In an unprecedented split, three members of the BoJ Monetary Policy Committee voted in favor of a rate hike. Although Governor Ueda was cautious about the outlook due to geopolitical risks, he emphasized the determination not to fall “behind” inflation. Moreover, the BoJ’s new forecasts now indicate that core inflation will remain above 2% through fiscal year 2028. In the absence of a significant worsening of the Middle East crisis, the BoJ will likely raise rates in the June or July meeting, aiming for a neutral level between 1.5% and 2% (i.e., a real rate of 0%) within the next 18 months. This should keep upward pressure on short-term Japanese Government Bond (JGB) yields and increase flattening pressure on the yield curve. Long-term JGB futures are already very high but could rise further if fiscal policy offsets the terms-of-trade shock caused by rising energy prices.
UNITED KINGDOM: NEUTRAL
Short-term rates in the UK have closely followed crude oil prices since the start of the Iran war, reflecting market fears that rising energy costs will keep UK inflation stubbornly high and force the Bank of England (BoE) to tighten monetary policy further. With oil prices returning to late-April highs, the UK rates market has priced in a cumulative BoE tightening of about 85 basis points by year-end, with 50 basis points expected by September.
AUSTRALIA: OVERWEIGHT
The Reserve Bank of Australia (RBA) raised rates by 25 basis points in May, bringing them to 4.35%, matching the post-Covid peak in interest rates. Inflation persistence and a strong labor market keep the RBA focused on price risks. Rising energy prices will likely reinforce policymakers’ caution on inflation, but weakening domestic confidence indicators will probably limit room for further tightening. The market is already pricing in 62 basis points of cumulative rate hikes this year, with long-term forward rates trading above 5%. Even considering recent upside inflation surprises, these valuations now appear attractive to us on an absolute basis and relative to US Treasuries. Australia has solid fiscal fundamentals, which should limit long-term risk premiums. Additionally, the Australian dollar’s appreciation over the past 12 months should curb imported inflation.
