Good case for reflation in the US; negative for yen – Danske Bank

Analysts at Danske Bank suggest that while inflation is likely to rise globally, they think the case for real reflation is strongest in the US, as the output gap is more or less closed and it is likely the economy will run hot over the next few years.

Key Quotes

“In our view, even without Trump’s fiscal expansion, reflation would play out. However, his policies are likely to add to the US reflation case – as Trump’s expected fiscal stimulus sets in at a time when we expect unemployment to be below NAIRU and wage pressure has risen. Markets have priced in an accumulated 65bp rate rise in the US from now until YE 2017 and, although we have already seen the US yield curve steepening and higher yields, we think yields could rise further in coming months.”

“Historically, USD/JPY has been highly correlated with yields on 10Y US Treasuries, as a widening of the rate spread tends to support portfolio investment flows out of Japan and into the US. If the US reflation theme continues to build, we see a case for further portfolio investment outflows out of Japan, which combined with higher FX hedging costs on USD assets is likely to weigh on the JPY medium term.”