Inflation/Deflation

Japan is in a liquidity trap: bad economic news is good for the yen while good economic news is bad for the yen. Chinese reflation could help risk assets in the months ahead, but poor EM fundamentals will reassert themselves later this year. The yen bull market is not over yet. The BoC was more positive on growth than anticipated. The BoE's Super Thursday was a non-event.

A stronger yen is hampering efforts to revive the Japanese economy and the BoJ's failed NIRP experiment leaves open the option of direct currency intervention. Probability is also high that the April 2017 sales tax hike will be postponed, perhaps indefinitely. A major stimulus package, "helicopter drops" of money, and a 4% inflation target may be the only way to permanently overcome deflation. Near-term, further yen strength is likely, but the long-term path is down.

Clients should forgive us for being too gloomy at the start of the year -- it is difficult to be optimistic in the dead of a Montreal winter. However, with springtime comes the reflation trade, born on the wings of massive Chinese fiscal and credit expansion. In this report, we discuss how long (not very) the trade can go (and how to play it). Our In Focus feature returns to pessimism, with a discussion of why the Anglo-Saxon laissez-faire economic model may be in for a big pendulum swing.

Chinese PPI deflation will likely continue to ease going forward. There are non-trivial odds that the PPI deflation may turn positive. Our models predict a sharp upturn in China's profit cycle. Meanwhile, Anti-corruption investigation cases have dropped substantially since the beginning of the year, a sign that the Communist Party may be reorienting priorities to boost economic growth.

Treasuries appear overbought in the near-term, especially given evidence of a rebound in global manufacturing, but we would need to see evidence of a sustained re-synchronization of global growth before advocating a shift to below benchmark duration on a 6-12 month horizon.

We are sending you the Q2 <i>Global Investment Strategy Outlook</i>, which discusses the ten predictions we expect to drive global financial markets throughout the rest of the year.

Fed dovishness is weakening the U.S. dollar. As the ECB and BoJ move to the sidelines and the Fed remains reluctant to hike rates, the euro and Japanese yen should continue to recover versus the greenback.

While the post-GFC linkage between oil prices and medium-term inflation expectations evident in the 5-year/5-year (5y5y) CPI swaps market will continue to be debated for years to come, this is an empirical fact that will affect monetary policy and the evolution of FX and real interest rates over the medium term.

The RMB has moderated considerably since mid-last year, which should lead to improved capacity utilization and easing PPI deflation. There is a strengthening case for an upswing in China's profit cycle, driven by falling interest rates and a weaker RMB, while investors are ill-prepared for any positive earnings surprises.

In this <i>Special Report</i>, we present a detailed discussion on the outlook for Australian credit markets. Our conclusion is that investors should begin increasing exposure to Australian spread product.