Markets focused on diverging monetary policy expectations as the Bank of Japan prepared to tighten policy while Western central banks moved toward rate cuts.
Markets enter the coming week pricing in a 90% probability that the US Federal Reserve will deliver a 25bps rate cut - its third of 2025. This follows a period of uneven economic data, further complicated by the recent 43-day government shutdown, which delayed the release of key inflation reports.
While headline CPI remains stubbornly around 3.0%, the Fed’s preferred inflation gauge, Core PCE, eased to 2.8% in the delayed September reading, providing just enough support for a further policy loosening. However, with inflation still above target and employment gains weakening, the likelihood of dissent within the Federal Open Market Committee remains elevated.
The risks are heightened by the pronounced divergence in global monetary policy expected next week. Whilst the Bank of England appears inclined to follow the Fed’s more dovish stance, the Bank of Japan is poised to raise rates. Such decoupling may steepen the Japanese yield curve and increase the risk of capital repatriation by Japanese investors - historically amongst the world’s most ardent savers.
Although parallel rate cuts in the UK and US may keep the GBP/USD exchange rate relatively range-bound, volatility could arise from movements in the Yen. A BoJ rate hike may strengthen the currency via repatriation flows, potentially delivering a windfall for international investors with unhedged Japanese equity exposure. However, this benefit could be offset by falling share prices in Tokyo’s exporter-heavy indices.
Against this backdrop, we have adjusted the T. Bailey funds’ allocation to Japanese equities. Last week we trimmed exposure to the Amundi Prime Japan UCITS ETF, thereby reducing our allocation to larger-capitalisation, export-oriented companies. At the same time, we increased the allocation to the actively managed WS Zennor Japan Equity Income Fund, where approximately 90% of holdings have a market capitalisation below US$5bn, offering greater exposure to mid-cap opportunities. Within the T. Bailey Multi-Asset funds, exposure to Amundi Prime Japan ETF was exited entirely, whilst the T. Bailey Global Thematic Equity Fund retains a modest 3.1% allocation to the ETF. Nonetheless, the portfolios are now more skewed towards these mid-cap, income-orientated holdings.
