Economic webcast

Here is our latest monthly economic webcast: “2023 in focus.”

A run of good news

As has been widely documented, economic news has skewed heavily in a positive direction over the past few months. Key positive developments include:

• Inflation continues to fall enthusiastically.
• China abandoned its zero- tolerance policy and is now positioned for a significant economic revival.
• Warmer weather in Europe paired with logistical and conservation efforts have made Europe’s energy outlook somewhat less precarious.
• Economic data in the developed world may be wobbling in places, but it has thus far refused to collapse.

But now too much optimism?

In short, over the course of just a few months, the world has gone from everything going wrong (with markets assuming a continuation of that gloomy trend) to several things suddenly going right (with markets now assuming that happy pattern continues).

We flag the possibility that this shift from extreme pessimism to substantial optimism is an overreaction. The truth likely lies in the middle. It is telling that a key theme to emerge from the recent Davos summit was one of renewed optimism: historically, Davos has been more wrong than right on such matters.

The world still faces a variety of challenges and risks, and while some of these can be expected to resolve happily, others could resolve unhappily. Outstanding macro challenges include:

• A recession remains likely due to tighter financial conditions.
• De-globalization is growth-negative and inflation-positive.
• China’s economy is still structurally constrained even as its cyclical impediments fade.
• The weaker U.S. dollar may complicate the decline in U.S. inflation.
• The war in Ukraine could get messier now that Russia has taken the town of Soledar, as the Wagner Group is given more control, and as Ukraine warns of a major Russian offensive to come.
• Japan could run into trouble as its inflation rises to unfamiliar levels and its central bank scrambles to control the bond market.

COVID concerns fade

The XBB family of COVID-19 sub-variants continues to take over after the BQ family’s short reign (see next chart).

XBB is now the dominant variant

As of 01/21/2023. Sublineages of BA.4 are aggregated to BA.4. Source: Centers for Disease Control and Prevention, RBC GAM

Despite this, the hospitalization rate is actually falling in key developed-world countries (see next chart), arguing that no global wave is accompanying the new sub-variant.

COVID-19 hospitalizations are falling in developed countries

Based on data available as of 01/22/2023. Source: Our World in Data, Macrobond, RBC GAM

Infection data is less reliable than it once was given sharply reduced testing, but it is nevertheless a promising sign that infections are falling in countries such as France, Germany and the U.S. – all of which had until recently been experiencing the opposite trend. Japan, which recently suffered through its worst wave yet, is now beginning to improve (see next chart).

COVID-19 cases and deaths in Japan are easing

As of 01/22/2023. 7-day moving average of daily new cases and deaths. Source: Our World in Data, Macrobond, RBC GAM

COVID-19 wave in China and economic update

That leaves China, which has gone through a massive wave of COVID-19 infections after ending its zero-tolerance strategy in early December. As we wrote two weeks ago, and now supported by additional evidence, we believe the country is already past the worst of its outbreak. We do not anticipate a significant further wave from Lunar New Year travel.

China’s National Health Commission reports that visits to fever clinics peaked on December 23, with a subsequent decline of more than 80%. The number of patients with severe symptoms peaked around January 6. The number of people in hospital with COVID-19 has already fallen by 40% between January 5 and January 17.

Reflecting the remarkable pace at which the outbreak streaked across the country, a study from Peking University estimates that 900 million of China’s 1.4 billion people had already caught COVID-19 by January 11.

Counter to the theory that rural areas might not yet have been fully hit, the National Health Commission says that the number of fever clinic visitors is falling in urban and rural areas alike. The province of Henan estimates that 90% of its population has already been infected, inclusive of rural areas. A doctor in a Henan village quoted in The Economist estimated that 90% of locals had already caught the virus. To be sure, rural areas are more vulnerable given older populations and fewer medical facilities. But the worst is probably over there, too.

The true fatality figures will likely be never known, as China has enforced an extremely narrow definition that only counts deaths in medical facilities for respiratory reasons. Doctors are said to be discouraged from citing COVID-19 on death certificates. The estimate of 60,000 deaths between December 8 and January 12 is thought to be an underestimate by at least a factor of 10 based on a range of models.

With the virus ebbing, the economy can begin to revive. This is not a moment too soon after a brutal 2022 in which the Chinese economy only expanded by 2.9%. Some real-time metrics such as subway usage have already increased in recent weeks. We figure Chinese data will significantly improve in February.

In theory, there should be considerable pent-up demand from Chinese consumers. More than 20 trillion yuan of excess household savings (around US$3 trillion) were accumulated over the past three years, with some set to be unleashed now that restrictions have ended. For context, a similar sum was saved in the U.S., with the result that consumers were eager spenders in 2021 and then proved unusually resilient over the past year even as economic headwinds mounted. Some caution is arguably needed in the Chinese context simply because Chinese households are famous for saving enormous sums of money during the best of times. But surely some of these savings will be unleashed.

Accordingly, the Chinese economy can probably accelerate to a 4—5% growth rate in 2023.

However, we remain cautious on China’s longer-run growth prospects. This is partially for demographic reasons, and partially because the housing market can no longer drive growth as it once did. It is also partially because productivity growth may be harder to come by. This last claim is motivated in part by China’s rising prosperity – which reduces the scope for outsized productivity growth in the future – and in part because the country continues to constrain or meddle with its private-sector corporate champions.

As an example of this, the government is increasingly taking a “golden share” in major tech companies. For a 1% stake in the company, the government receives outsized control. For instance, with ByteDance, the owner of TikTok, this gives the government one of the three members of the board of directors. It is hard to imagine the two private citizens being bold enough to vote down the government representative on key strategic matters such as acquisitions, how profits are distributed and remuneration. Further, the government representative has complete say over Chinese content on the platform.

Now, the government is acquiring a golden share in tech giants Alibaba and Tencent, presumably with similarly stifling implications.

Economic trends

A range of economic data has recently weakened.

Prominently, U.S. retail sales fell by a sharp 1.1% in December, after a 1.0% decline in November. This suggests consumers are finally starting to roll over after months of reducing their savings rate to maintain spending even as the economy slowed. However, the decline so far should not be overstated as consumer prices have fallen lately, meaning that consumers are paying less but not necessarily getting that much less (see next chart). Still, further weakening is likely from here.

U.S. consumption is flattening out after adjusting for inflation

As of November 2022. Source: U.S. Bureau of Economic Analysis (BEA), U.S. Census Bureau, U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

Incidentally, U.S. consumers are also starting to scale back their ravenous appetite for durable goods. Many of these are big-ticket items like vehicles, furniture, appliances and electronics (see next chart). We believe there is still a while to go before they revert to the pre-pandemic norm, however.

U.S. consumer spending on durable goods has plateaued

As of November 2022. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM

In the U.K., retail sales also fell in December, with a real 1% month-over-month decline.

Outside of the consumer space, U.S. industrial production fell by 0.7% in December after a 0.6% drop in November. Employment may not be weakening (yet), but other key components of the U.S. economy are.

Falling projections

The World Bank recently published its latest semi-annual economic forecast. The global growth forecast for 2023 was revised sharply downward. It dropped from a prediction of 3.0% growth last summer to just 1.7% growth today. The U.S. outlook was pared from +2.4% to +0.5%. The outlook for China slipped from +5.2% to +4.3% despite the recent reopening.

Meanwhile, in the corporate space, the S&P 500 earnings consensus for 2023 has fallen from $240 last summer to around $228 today. It continues to descend. We believe stock market valuations are reasonable, but earnings expectations remain somewhat too strong.

Weaker trade

Global trade appears to be weakening, though this can be difficult to disentangle from distortions related to currency movements and inflation movements. When we do our best to control for this, trade is now very tentatively beginning to decline (see trade volume line on next chart). This points to weakening global demand.

Global trade fell in both nominal and real values

As of October 2022. Source: CPB Netherlands Bureau for Economic Policy Analysis, Macrobond, RBC GAM

In the U.S., real exports and imports are both in decline, though this is probably somewhat overstated due to U.S. dollar strength over the past year (see next chart).

U.S. goods exports and imports have started to fall

As of November 2022. Shaded area represents recession. Source: U.S. Census Bureau, Macrobond, RBC GAM

Finally, while Chinese exports and imports in U.S. dollars are in significant retreat on an annual basis, its exports and imports in renminbi have only decelerated to flat readings (see next chart).

Chinese trade growth decelerates

As of December 2022. Shaded area represents U.S. recession. Source: Macrobond, RBC GAM

Canada softening

Two weeks ago, we wrote about weakening business conditions in Canada according to Statistics Canada’s Real-time Local Business Conditions Index. The Index had fallen to the sharpest extent in several years. However, the subsequent week revealed an even sharper revival, confusing the interpretation (see next chart).

Business conditions in Canada rebound after the holidays

As of the week of 01/02/2023. Equal-weighted average of Business Conditions Index of Calgary, Edmonton, Montreal, Ottawa-Gatineau, Toronto, Vancouver and Winnipeg. Source: Statistics Canada, Macrobond, RBC GAM

Notwithstanding this data, most evidence in Canada continues to argue the country is actually slowing, and so we stick with that view. Prominent among these, the Bank of Canada’s Business Outlook Survey makes several claims to this effect.

1. More Canadian firms now expect their sales volume to decline over the next year than at any point outside the past two recessions (see next chart).

Canadian firms’ expectations of future decline in sales volume

As of Q4 2022. Source: Bank of Canada, RBC GAM

2. The overall assessment remains weak and consistent with the pessimism expressed over the prior three quarters (see next chart). Note this finding is based on all sales expectations rather than just those that are negative (as in the previous chart).

Canadian Business Outlook Survey findings remain weak: Future Sales Index

As of Q4 2022. Source: Bank of Canada Business Outlook Survey, Macrobond, RBC GAM

3. Canadian firms continue to scale back their hiring and investment plans (see next chart).

Canadian firms reduce hiring and investment plans

As of Q4 2022. Source: Bank of Canada, Macrobond, RBC GAM

Elsewhere, the notoriously volatile Canadian Ivey Purchasing Managers’ Index (PMI) has fallen to a two and a half year low. The number of active businesses in Canada has also begun to edge lower after a long increase (see next chart).

Number of active businesses in Canada has declined from May 2022 peak

As of September 2022. Source: Statistics Canada, Macrobond, RBC GAM

White collar job losses?

Anecdotally, the limited labour market weakness that has been visible so far in the U.S. economy has been disproportionately white-collar in nature, originating largely from the tech and financial sectors. This runs counter to the traditional sequence of capital-intensive industries such as manufacturing and construction laying off first, followed by low-skilled service workers, with white collar workers being impacted last (and, usually, least).

As we wrote in the December 20 #MacroMemo , tech sector layoffs are due to a combination of industry-specific idiosyncratic factors and broader economic conditions. Financial sector layoffs – still only nascent – relate primarily to the conviction of many bank CEOs that a recession is coming, informed, one presumes from their intimate familiarity with the damage inflicted by rising rates.

In contrast, wage gains have been strongest among low-skilled workers over the past year. Although McDonald’s recently announced layoffs, they are in the corporate office rather than at the restaurant level.

The situation for tech workers isn’t quite as bad as it first looks. Yes, layoffs.fyi estimates that 158,951 lost their jobs in 2022 and 56,570 so far in 2023. But that is a global figure, and is tiny relative to the 4 million information technology workers in the U.S., let alone the 10 million-plus likely employed around the world. Furthermore, ZipRecruiter estimates that 79% of the tech workers recently laid off found another job within three months.

In other words, to less acclaim, some tech companies are still hiring. The latest U.S. payrolls report revealed a small net loss in tech jobs for the first time.

Fascinatingly, unemployment rates by education level don’t show much action so far. Unemployment is roughly flat for all levels of education. The unemployment rate for the highly educated is lowest, but it always is. For a moment, it had actually appeared that the least educated workers were beginning to suffer job losses – completely contrary to the anecdotal evidence discussed above. But more recent data has unwound that blip (see next chart).

Unemployment rate for the least educated fell considerably in November

As of December 2022. Shaded areas on the chart represent recessions. Source: U.S. Bureau of Labor Statistics (BLS), National Bureau of Economic Research (NBER), Macrobond, RBC GAM

We would suggest that any job losses in the next recession are both milder than usual on the whole, and slightly less focused on low-skill service workers. But job losses of some description are nevertheless likely across most sectors.

Given a fixed number of job cuts, is it better or worse for the economy that these accrue to white collar workers? It isn’t clear. On the one hand, these employees tend to earn larger incomes that will now vanish, disproportionately affecting consumer spending, tax revenue, and so on. On the other hand, these workers are usually further from poverty and less likely to default on their debt, reducing the risk for cascading problems elsewhere.

Sticking to the labour market but abstracting away from job type, initial jobless claims in the U.S. may remain extremely low, but the number of continuing jobless claims has increased (see next chart). Apparently, those already unemployed are not finding new jobs quite so readily as before.

U.S. insured employment is rising

As of the week ending 12/24/2022. Source: Department of Labor, Macrobond, RBC GAM

Recession musings

Near-unanimous CEO survey

A startling survey from the U.S. Conference Board finds that fully 98% of U.S. CEOs expect a recession, although 85% of respondents expect it to be shallow and short.

Of course, once a recession appears even reasonably likely, it would be dangerous for a CEO to say anything else, and career suicide to fail to prepare their company for a recession scenario. Executives may also benefit from the view that a recession is coming as it provides cover for making large corporate changes, be it laying off underperforming employees or abandoning unprofitable business lines.

It is also worth flagging that having 98% of people predict something is quite different than saying it has a 98% chance. It simply means that 98% of people believe the outcome has a greater than 50% chance. In short, nearly every CEO thinks a recession is likely. We concur that a recession is likely, though it is not certain.

‘Stall speed’ argues against soft landing

The concept of ’stall speed’ is suddenly quite important for gauging the economic outlook in 2023. The basic notion is that, once economies have descended sufficiently far below their ’normal’ growth rate, economic actors become sufficiently distressed that an outright recession manifests unavoidably (see next chart).

‘Stall speed’ argues against soft landing

As of Q3 2022. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM

From World War II through to the early 2000s, there was only one occasion out of eleven instances when growth of real U.S. Gross Domestic Product (GDP) fell below +2.0% year-over-year (YoY) without a recession (and an outright annual GDP decline) occurring shortly thereafter. This happened in the early 1950s.

But that specific 2% threshold no longer seems to apply. Growth below 2% used to be considered quite bad. But in this era of slow population growth and sluggish productivity growth, it is roughly normal. There have been multiple occasions over the past 20 years when growth fell below 2% without a recession happening.

Instead of abandoning the concept, we theorize that the new U.S. stall speed is simply lower, perhaps in the realm of +1.0% YoY real GDP growth. That matters a lot, because a large number of forecasters anticipate a so-called soft landing in which the economy just barely avoids a recession. The Federal Reserve, for instance, anticipates a trough of +0.5% real GDP growth. But this could be all but impossible, because once growth falls below 1% the economy is likely to stall into a full-fledged recession with GDP below 0%.

Recession timing

We will admit to being surprised that a recession has taken so long to manifest. But arguably we shouldn’t be.

Theory says that the full effect of a rate hike isn’t felt for up to 18 months. This means that even as rate hikes slow, the economic effect should continue to mount across much of 2023.

Another recession timing tool is based on when the yield curve inverts. The U.S. 2-year-10-year portion of the curve inverted in March 2022, and usually anticipates a recession by 18 months. The 3-month-10-year part of the curve inverted in October 2022 and usually precedes a recession by 11 months. These both point to recessions starting around September 2023.

We still believe a recession could begin sooner than that, but a delayed start this coming fall is also quite possible based on these historical guides.

More inflation good news

The inflation story remains largely good as pressure continues to abate.

Happily, the consensus 2023 inflation forecast for a range of nations finally began to descend with enthusiasm in January. The month witnessed a cut to the inflation outlook for the largest number of nations since June 2020 – long before inflation began to rear its head.

In the U.S., small businesses recently resumed paring their price hiking plans. There had been a major improvement in the summer and early autumn, but that progress had stalled out for a few months before the December report revealed another welcome leap lower (see next chart). Pricing plans are almost back to pre-pandemic norms – a wonderful signal for inflation.

Fraction of U.S. businesses planning to raise prices is falling precipitously

As of December 2022. Shaded area represents recession. Source: NFIB Small Business Economic Survey, Macrobond, RBC GAM

Inflation reports

Year-over-year U.S. Consumer Price Index (CPI) for December managed a sixth straight monthly deceleration, from 7.1% to 6.5% YoY. It had peaked at 9.1%. Core inflation also eased on an annual basis, from 6.0% to 5.7%, though several monthly core proxies rose slightly (see next chart).

U.S. core inflation metrics have eased

The Personal Consumption Expenditures (PCE) deflator as of November 2022, CPI measures as of December 2022. Source: Macrobond, RBC GAM

Goods inflation is getting nicely under control, but more time is needed for service inflation to be tamed (see next chart). Much of this relates to the cost of shelter, which is already easing in the real world but operates with a lag within the CPI.

U.S. goods inflation is falling, services inflation may be stabilizing

As of December 2022. Shaded area represents recession. Source: BLS, Macrobond, RBC GAM

Fortunately, a previously stubborn inflation component – food prices – finally started to decelerate on an annual basis (see next chart).

U.S. food inflation falls tentatively

As of December 2022. Shaded area represents recession. Source: BLS, Macrobond, RBC GAM

Furthermore, inflation became somewhat less broad, meaning that a variety of small inflation drivers became less intense over the past month, continuing a nascent trend (see next chart).

Inflation in the U.S. is quite broad, but finally narrowing

As of December 2022. Share of CPI components with year-over-year % change falling within the ranges specified. Source: Haver Analytics, RBC GAM

The U.S. Producer Price Index (PPI) descended by 0.5% month-over-month (MoM), with core PPI up by just 0.1% MoM. This is promising for future consumer prints.

In Canada, December CPI fell by 0.5% on a non-seasonally adjusted basis. As a result, annual inflation descended from 6.8% to 6.3% YoY. Inflation less food and energy drifted slightly lower, to 5.3% YoY. To the extent the prior month’s inflation figures hadn’t cooperated as much as hoped, this month worked slightly better. Still, the rate of inflation in Canada is falling less enthusiastically than in the U.S. so far. This may be in part because the U.S. was benefiting from the deflationary effects of a strong U.S. dollar.

Canadian businesses continue to expect their input and output inflation to slow (see next chart).

Canadian firms expect lower input and output inflation

As of Q4 2022. Source: Bank of Canada, Macrobond, RBC GAM

Artificial inflation weakness

Inflation has softened, in some cases quite a lot, and prices are even falling outright some months. This is wonderful news. However, we can’t guarantee inflation has been licked yet.

This is in part because new forces could manifest in the future. Think of China’s reviving economy increasing base metal and energy prices; or the risk that the war in Ukraine escalates further, also with inflationary consequences via commodity prices.

It is also because current deflationary pressures are partly artificial. Oil prices went up a lot, and have since come down somewhat. It is reasonable to think they could fall a bit further, but not that they will fall forever. It is the same with used car prices and many other products that were distorted by the pandemic. Their prices are now falling – an entirely reasonable outcome after earlier spikes – but not a trend that can persist forever.

In turn, we cannot say that the 0.15% monthly inflation rate averaged in the U.S. over the past six months is sustainable. It is being helped by artificial weakness. We believe the true trend – and good luck defining ’true’, though in this case let us use core inflation – is +0.38% MoM. That annualizes to a 4.7% inflation rate, which remains well above desirable levels.

In our opinion, the bottom line is that the inflation momentum is fantastic and there are many reasons to think that inflation is pivoting from a problematic equilibrium to a benign one. But there is still a bit more work to be done before we can say that inflation has fully normalized after the reverse distortions are factored out.

Central banks finishing rate hikes

North American central banks are nearing the finish line for their rate hikes.

The Bank of Canada is expected to deliver a 25 basis point rate hike on January 25, raising the overnight rate to 4.5%. Although economic surveys are weakening, inflation has not come down forcefully enough to pull the Bank of Canada to the sidelines yet. After the expected rate increase, that could be it for the central bank, which markets believe could even start to reduce the policy rate late in the year.

The Federal Reserve still has a week until its February 1 decision, which is now expected to be a mere 25 basis point rate increase, to the range of 4.5—4.75%. The market then assumes a further rate increase in March, with the policy rate peaking in the realm of 5.0%.

Conversely, the European Central Bank is expected to be more aggressive on February 2, with a 50 basis point increase (from 2.0% to 2.5%). It is playing catch-up to other central banks and grappling with higher inflation than most other jurisdictions. Expectations are then for a further 50 basis point rate hike in March.

The Bank of England is also meeting on February 2, and also expected to deliver a 50 basis point rate increase (from 3.5% to 4.0%), though there is a chance it may be only 25 basis points. The expected eventual peak is in the realm of 4.5%. This is well down from brief expectations in September for a policy rate as high as 6% when the country was suffering a fiscal credibility crisis.

Debt ceiling complications in U.S.

Unlike most countries, the U.S. has a limit on how much federal debt it can issue. This limit must be increased before the country can borrow more money, even though the government’s revenues and expenditures are already determined by legislation.

In this era of perpetual deficits, the public debt is always rising. The debt ceiling is thus bumped into regularly, and most of the time it is increased without too much hassle. Congress has raised the debt limit 78 times since 1960.

Technically, the debt ceiling was reached again on January 19, but the Treasury Department has enough accounting tricks that it can keep functioning until June of 2023.

There are widespread expectations that this debt ceiling increase will be more contentious than most. After the midterm elections, Congress is now divided, adding significant complexity. Further, the Democrats are unusually fractured in the Senate, despite possessing a majority, due to the presence of several Senators with their own agendas.

As the true deadline approaches in the coming months, pundits will again debate whether more exotic tricks might be used to avoid defaulting on the public debt, such as issuing a trillion dollar coin, invoking the 14^th Amendment to revoke the debt ceiling, or creating a new class of bonds. These are all unlikely, though they do emphasize that the U.S. is quite unlikely to actually default on its debt.

The most likely scenario is that Democrats grudgingly make small political concessions to Republicans at the last moment, allowing the debt ceiling to be increased without any real economic or financial market damage.

An unhappy scenario would be akin to the near-miss of 2011, when the political fight was sufficiently intense that the Standard & Poor’s rating agency downgraded the U.S. debt rating from AAA to AA+: an unprecedented action and a change that persists to this day. The stock market temporarily fell by 15% during the 2011 crisis and the U.S. 10-year yield plummeted as investors’ desire for a safe-haven asset exceeded their fear of being defaulted upon. The 10-year yield fell from 3.0% in the final week of July to a low of 2.11% by August 10 of that year – a huge move. This backfired politically for the Republican Party, which suffered a sharp decline in popularity due to its negotiating tactics.

Economic risks for Japan

Japan is at a pivotal moment on multiple fronts. Its inflation rate has surged well past the country’s target. However, unlike nearly everywhere else, this is still viewed in a positive light given the country’s long struggle to sustain positive inflation.

The Bank of Japan is simultaneously grappling with distortions in its sovereign bond market. By virtue of the central bank’s heavy intervention in the market – it now owns fully half of the country’s entire stock of sovereign bonds – the market is highly illiquid. Furthermore, the yield curve is distorted by the central bank’s concentrated purchase of 10-year yields, creating a divot at that point of the curve.

The Bank of Japan has already increased the range of its target for the 10-year yield once, and is increasingly likely to have to do it again given that its efforts have not yet alleviated market pressures nor resolved liquidity concerns.

The entire yield curve control framework may be abandoned altogether, depending on who is nominated to replace outgoing Bank of Japan Governor Kuroda when his term expires in April. The yen has soared in response to all of this.

The Japanese Prime Minister has indicated he will make a decision in February, with reports that a decision may be made by February 10. Former Deputy Governor Nakaso is thought most likely to be selected, and he recently wrote a book about how Japan might exit from the system of yield curve controls.

The prospect of further increases in sovereign yields is of outsized importance to Japan. The country has the largest sovereign debt load in the world relative to the size of its economic engine, at around 260% of GDP. Approximately 8% of its national budget is spent on interest payments, and this increases sharply for every 25 basis point increase in borrowing costs. One estimate claims that every such increase would eat a further 10% of the government’s budget.

Of course, half of this debt is held by the central bank, which repatriates its profits (including interest earnings) back to the government. But the Bank of Japan itself suffers massive losses on these holdings as yields rise. These stay on paper if the central bank holds the bonds to maturity, but if it is forced to begin unwinding its purchases, those losses become very real, and of consequence to the sovereign.

Japanese banks also hold US$1.1 trillion in Japanese sovereign debt, and are set to lose significant sums of money as yields rise (and bond prices thus fall).

International flows may also be significantly affected. Japan has more than US$2 trillion in overseas investments, of which U.S. sovereign bonds are around half. As interest rates become more attractive within Japan, some of this money flows back to Japan, raising borrowing costs elsewhere and reducing the supply of international capital.

Suffice it to say, there are a lot of moving parts. In our opinion, a best-case scenario is where Japan manages to sustain mildly positive inflation while escaping from the shackles of negative rates and its system of yield curve controls. In a worst-case scenario, significant fiscal and financial problems arise as yields rise. In a most-likely scenario, Japan continues to muddle along.

-With contributions from Vivien Lee, Vanessa Adams and Aaron Ma