Here’s what’s at stake for markets as the Bank of Japan remains dovish

After a week of historic rate hikes and aggressive moves by the Federal Reserve and other major central banks, the Bank of Japan has rarely looked so much like a rebel against the consensus.

And after its two-day monetary policy meeting on Friday, the BOJ left interest rates at ultra-loose levels, as expected, despite a falling Japanese yen.

Unfortunately for some investors, the BOJ’s refusal to heed market demands has come at a price. And judging by the recent market movements in the dollar-yen currency pair USDJPY,
Japanese stocks NIK,
(which fell in Friday trading) and the Japanese government bond market – which the BOJ has long supported with seemingly bottomless offers – it looks like the central bank has locked itself in a battle with foreign speculators, analysts said.

Despite the central bank stepping up its bond purchases earlier in the week, Japanese government bonds, particularly those below the 10-year mark, have seen yields move inversely with prices.

The sell-off cooled on Thursday as the Bank of Japan’s two-day meeting got underway, and yet the damage has largely been done. Bloomberg reported that the Bank of Japan could suffer “huge losses” on its $4 trillion government debt if it abandons its easy money policy.

Additionally, hopes among economists and market participants that the Bank of Japan might make a mildly dovish adjustment to its yield curve control policy led to a whiplash in markets – the dollar-yen currency pair USDJPY,
on Thursday seemed set for the biggest two-day correction since March 2020.

Jens Nordvig, the founder and CEO of Exante Data and a longtime forex markets guru, noted via Twitter that the scramble to hedge against a more assertive tone from the Bank of Japan was quite intense.

Analysts at Japanese banks have been eerily silent on what that shift might look like, and economists and market strategists watching from abroad dared to speculate that BOJ Governor Haruhiko Kuroda and his team could eventually ease the acceptable yield spreads for JGBs — although there is broad consensus There seems to be some sort of substantive move by the central bank on Friday that would be highly uncharacteristic.

If it does, it’s possible the move could look like an expansion of the central bank’s acceptable range for JGB yields on bonds and bills with the shortest maturities over the 10-year period. But even that seems relatively modest when viewed in the context of what the rest of the world’s central banks — with the Federal Reserve front and center — appear to be doing.

The rise in JGB yields appears to have petered out (at least for now) and the dollar staged a notable reversal, falling more than 2% against the yen on Thursday, its biggest two-day drop since March 2020. But analysts say the fact remains that the state of Japan’s 10-year yield curve signals investors are ready to take on the BoJ, as the bank has bought trillions of dollars worth of bonds just for status to maintain quo. If it stays at current rates, it will have bought about 10 trillion yen (worth about $75 billion) by June.

“This is really an extremely high level of money printing,” said George Saravelos of Deutsche Bank.

What’s at stake?

Saravelos warned that if confidence in the BOJ’s ultra-loose policies wanes, the result could be chaos in Japanese stocks and securities.

“When it becomes obvious to the market that the clearing level of JGB returns is
What is the incentive to hold bonds above the BoJ’s 25 basis point target?” Saravelos said. “Is the BoJ ready to take over the entire stock of Japanese government bonds?”

“Where is the yen’s fair value in this scenario and what happens if the BoJ
changes his mind?” he said.

But not only Japan will be affected – far from it. Analysts said ripples could spread across stocks and equity markets across Asia and perhaps Europe and the US.

Continued US dollar strength is increasing market sensitivity around the world, making life harder for emerging market companies and governments to service their debt. That’s one of the reasons why rate hike cycles can sometimes help provoke problems like the “tequila crisis” of 1994.

Of course, the Bank of Japan wouldn’t want a repeat of that either.

how did we get here

Luckily for the Bank of Japan, markets are getting a little respite on Thursday as weak US economic data comes just ahead of their big interest rate decision, according to Steve Englander, FX strategist at Standard Chartered Bank.

US jobless claims lingered near five-month highs last week and housing starts signaled trouble could be brewing in the US housing market (both could be interpreted as positive developments on the Federal Reserve’s agenda).

Japan and the BOJ struggled for years to push up inflation and return the Japanese economy to a more dynamic growth state. Unfortunately, a number of factors, including demographic issues, have held this back.

Now the BOJ must find the sweet spot where it can accommodate investors who are demanding a dramatic change in course without giving up 100% control of the narrative to speculators 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 is like, ‘That looks reasonable,’ you’re going to be under that pressure.” Here’s what’s at stake for markets as the Bank of Japan remains dovish

Brian Lowry

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