After a week of historic rate hikes and aggressive action by the Federal Reserve and other major central banks, the Bank of Japan has hardly ever looked more defiant of the consensus.
And following the close of its two-day policy meeting on Friday, the BOJ is expected to leave interest rates at ultra-loose levels, despite the falling Japanese yen.
Unfortunately for some investors, the BOJ’s refusal to accede to market demands comes at a price. And judging by the recent market turmoil in the dollar-yen currency pair USDJPY,
Japanese stocks NIY00,
(which rebounded on Thursday after falling earlier in the week) and the Japanese government debt market – which the BOJ has long supported with a seemingly bottomless bid – it looks like the central bank has gotten itself stuck in a battle with foreign speculators, analysts said.
Although the central bank stepped up its bond buying earlier in the week, Japanese government bonds, especially at durations below 10 years, saw yields, which move opposite to prices, rise. .
Selling cooled on Thursday as the Bank of Japan’s two-day policy meeting began, and yet the damage was largely done. Bloomberg reported that the Bank of Japan could face “huge losses” on its $4 trillion in government bonds if it abandons its easy money policy.
Additionally, hope among economists and market participants that the Bank of Japan might make a slightly accommodative adjustment to its yield curve control policy caused markets to drift – the dollar-yen currency pair USDJPY ,
Thursday appeared to be heading for its biggest two-day correction since March 2020.
Jens Nordvig, the founder and CEO of Exante Data and a longtime currency market guru, noted via Twitter that the scramble to hedge against a more assertive tone from the Bank of Japan has been quite intense.
As for what that change might look like, analysts at Japanese banks have remained eerily silent, and economists and market strategists watching from abroad have ventured to speculate that BOJ Governor Haruhiko Kuroda and his team could possibly loosen the acceptable return ranges. for the JGBs – although there seems to be a broad consensus that any kind of substantial move from the central bank on Friday would be extremely out of place.
When it does, the move may look like a widening of the central bank’s acceptable range for JGB yields on bonds and bills with the shortest maturity up to 10 years. But even that seems relatively modest when considered in the context of what the rest of the world’s central banks – with the Federal Reserve at the forefront – seem to be doing.
The surge in JGB yields appears to have subsided (at least, for now), and the dollar made a notable reversal, weakening more than 2% against the yen on Thursday in its biggest decline in two days since March 2020. But analysts say the fact remains that the state of the Japanese 10-year yield curve signals that investors are ready to do battle with the BoJ, as the bank has bought billions of dollars of obligations just to maintain the status quo. If it persists at the current rate, it will have purchased some 10 trillion yen (worth around $75 billion) by June.
“This is a really extremely high level of money printing,” said Deutsche Bank’s George Saravelos.
What’s at stake?
Saravelos warned that if faith in the BOJ’s ultra-loose policy gave way, the result could be chaos in Japanese stocks and shares.
“If it becomes apparent to the market that the equilibrium level of JGB returns is
above the BoJ’s 25 basis point target, what is the incentive to hold more bonds? said Saravelos. “Is the BoJ willing to absorb the entire stock of Japanese government bonds?”
“Where is the fair value of the yen in this scenario and what happens if the BoJ
change of opinion ? he said.
But it’s not just Japan that will be affected, far from it. Analysts said the ripples could spread through stock and equity markets in Asia, and possibly Europe and the United States as well.
The increased strength of the US dollar is heightening market sensitivities around the world by making it more difficult for companies and governments in emerging markets to service their debt. This is one of the reasons why cycles of rising rates can sometimes contribute to problems like the “tequila crisis” of 1994.
Of course, the Bank of Japan wouldn’t want that to happen again either.
How did we come here?
Fortunately for the Bank of Japan, markets are getting some breathing room on Thursday with weak US economic data coming just ahead of their big rate decision, according to Steve Englander, FX strategist at Standard Chartered Bank.
U.S. jobless claims persisted near five-month highs last week, and housing starts signaled trouble may be brewing in the U.S. housing market (both of which can be interpreted as positive developments in the economy). Federal Reserve agenda).
Japan and the BOJ have been battling for years to try to drive up inflation and bring the Japanese economy back to a more buoyant state of growth. Unfortunately, a multitude of factors, including demographic issues, have held it back.
Now the BOJ needs to find the right place where it can accommodate investors demanding a radical change in policy, while not ceding 100% control over the narrative to speculators and bond vigilantes.
“The problem with that is that once you let go a little, the market expects you to let go a lot,” Englander said. “Until you get to a level where the market says ‘this seems reasonable’, they’re going to deal with that pressure.”