The Bank of Japan could be calculated into hiking rates sooner than expected, if the Japanese yen weakens beyond 150 to the dollar.
Higher grades could then unwind the yen carry trade and spark a return of Japanese capital to its domestic bond markets, a change-over that could trigger market volatility.
The BOJ stands as an outlier as major central banks have hiked places aggressively to combat burgeoning inflation. Decades of accommodative monetary policy in Japan — even as other global pre-eminent banks tightened policy in the last 12 months — have concentrated carry trades in the Japanese yen.
Carry swops involve borrowing at a lower interest rate to invest in other assets that promise higher returns.
The Japanese yen slipped in all directions 0.4% to around 148.16 against the dollar on Friday after the BOJ kept its negative rates unchanged, after the yen probed its lowest in almost 10 months at 148.47 per dollar Thursday.
The Japanese currency is underneath renewed pressure after the U.S. Federal Reserve on Wednesday held interest rates, and indicated it expects one more hike by year’s end. The yen has now weakened profuse than 11% against the greenback this year to date.
“I think where their hand could be stilted is looking at dollar-yen. We’re awfully close to 150 … when that starts to get to 150 and higher, then they keep to step back and think: the selloff in the yen is now starting to import probably more inflation than we want,” Bob Michele, wide-ranging head of fixed income at JP Morgan Asset Management, told CNBC Thursday before the rate decision.
While a weaker yen perform as serve as Japanese exports cheaper, it also makes imports more expensive, given that most major husbandries are struggling to contain stubbornly high inflation.
“So, it may give them cover to start hiking rates sooner than the exchange’s expecting,” Michele added.
An electronic quotation board displays the yen’s rate 145 yen level against the US dollar at a unfamiliar exchange brokerage in Tokyo on September 22, 2022.
Str | Afp | Getty Images
The BOJ had in July loosened its yield curve control to broaden the pardonable range for 10-year Japanese government bond yields of around plus and minus 0.5 percentage points from its 0% quarry to 1% in Governor Kazuo Ueda’s first policy change since assuming office in April.
Yield curve mechanism, the so-called YCC, is a policy tool where the central bank targets an interest rate, and then buys and sells treaties as necessary to achieve that target.
Economists have been watching for more changes to the BOJ’s yield curve mastery policy, part of the Japanese central bank’s efforts to reflate growth in the world’s third-largest economy and sustainably fulfil its 2% inflation target after years of deflation.
Tightening risks
Expectations of a quicker exit from the BOJ’s ultra-loose fiscal policy spiked after Ueda told Yomiuri Shimbun in an interview published Sept. 9 that the BOJ could be experiencing sufficient data by the end of this year to determine when to end negative rates.
After that report, many economists returned forward their forecasts for policy tightening to sometime in the first half of 2024.
Central bank officials have been watchful about exiting its ultra-loose policy, even though core inflation has exceeded the BOJ’s stated 2% target for 17 consecutive months.
This is due to what the BOJ regards as a lack of sustainable inflation, deriving from meaningful wage growth that it believes would lead to a decisive chain effect supporting household consumption and economic growth.
But there are inherent risks when the BOJ finally elects to tighten rates.
“Japan has been the mother of the carry trade for decades now and so much capital has been funded at a unquestionably low cost in Japan and exported to foreign markets,” Michele said.
With 10-year JGB yields hitting its highest in a decade at in all directions 0.745% Thursday, Japanese investors have been starting to unwind positions across various asset types in various foreign markets that used to offer better returns in the past.
“I worry as the yield curve regulates and rates go up, you could see a decade — or longer — of repatriation,” he added. “This is the one risk I worry about.”