After a week of historic rate hikes and aggressive moves by the Federal Reserve and other major central banks, the Bank of Japan has hardly ever seemed more like a rebel bucking the consensus.
And after its two-day policy meeting closes on Friday, the BOJ is expected to leave interest rates very loose, despite the Japanese yen’s slide.
Unfortunately for some investors, the BOJ’s refusal to accede to market demands has come at a price. And judging by the recent market turmoil in the dollar-yen currency pair
(which rallied on Thursday after sinking earlier in the week) and the Japanese government debt market, which the BOJ has long backed with a seemingly bottomless offering, it appears the central bank has found itself entrenched in a battle with foreign speculators, analysts said. .
Despite the central bank increasing its bond buying earlier in the week, Japanese government bonds, particularly in durations below the 10-year mark, have seen yields rise, moving in the opposite direction to prices. .
The sell-off cooled on Thursday as the Bank of Japan’s two-day monetary policy meeting began, and yet the damage has largely been done. Bloomberg reported that the Bank of Japan could face “enormous losses” on its $4 trillion treasury of government bonds if it abandons its easy-money policies.
Additionally, hope among economists and market participants that the Bank of Japan might make a slightly dovish adjustment to its yield curve control policy sent markets reeling – dollar-yen currency pair
on Thursday appeared to be headed for its biggest two-day correction since March 2020.
Jens Nordvig, founder and CEO of Exante Data and a long-time forex guru, noted via Twitter that the fight to guard 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 been eerily quiet, and economists and market strategists watching from abroad have ventured to speculate that BOJ Governor Haruhiko Kuroda and his team could eventually reduce the acceptable performance ranges. for JGB, although there seems to be broad agreement that any kind of substantial move by the central bank on Friday would be grossly out of the question.
When it arrives, the move may look like a widening of the central bank’s acceptable range for JGB yields for bonds and bills maturing shorter than 10 years. But even this seems relatively modest when viewed in the context of what the rest of the world’s central banks seem to be doing, with the Federal Reserve front and center.
The surge in JGB yields appears to have subsided (at least, for now), and the dollar has seen a notable reversal, weakening more than 2% against the yen on Thursday in its biggest two-day drop since March 2019. 2020. But analysts say the fact remains that the state of the Japanese 10-year yield curve indicates that investors are ready to take on the BoJ, as the bank has been buying trillions of dollars worth of bonds just to hold the status quo If it persists at the current rate, it will have bought about 10 trillion yen (worth about $75 billion) in June.
“This is a truly extreme level of money printing,” said George Saravelos of Deutsche Bank.
What is at stake?
Saravelos warned that if he gives up confidence in the BOJ’s ultra-loose policy, the result could be chaos in Japanese stocks and equities.
“If it becomes obvious to the market that the compensation level of JGB returns is
above the BoJ’s 25 basis point target, what is the incentive to keep holding bonds?” Saravelos said. “Is the BoJ willing to absorb all Japanese government bond stocks?”
“Where is the fair value of the yen in this scenario and what happens if the BoJ
change your mind? he said.
But it is not only Japan that will be affected, far from it. Analysts said the ripples could spread through Asian stock and equity markets, and perhaps Europe and the United States as well.
The stronger US dollar is heightening market sensitivities around the world by making it harder for emerging market corporations and governments to service debt. It’s one of the reasons that cycles of rate increases can sometimes help cause 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?
Fortunately for the Bank of Japan, markets are getting some relief on Thursday from weak US economic data just ahead of its big rate decision, according to Steve Englander, currency strategist at Standard Chartered Bank.
US jobless claims remained near five-month highs last week, and housing starts signaled trouble might be emerging in the US housing market (which could be interpreted as positive developments in the US). the Federal Reserve’s agenda).
Japan and the BOJ fought for years to try to increase inflation and return the Japanese economy to a state of more dynamic growth. Unfortunately, a number of factors, including demographic issues, have held it back.
Now, the BOJ needs to find the sweet spot where it can accommodate investors demanding radical policy change, while not ceding 100% control over the narrative to speculators and bond watchers.
“The problem with that is that once you drop a little bit, the market anticipates that you’ll drop a lot,” Englander said. “Until you get to a level where the market says ‘this looks reasonable,’ they will face that pressure.”