Why Bank of Japan may shake up financial markets before Fed’s next interest-rate decision
MARKET EXTRA
Japan — the world’s last bastion of negative interest rates — appears ready to tighten its monetary policy next Tuesday, raising the potential for a mild to more forceful reaction in financial markets a day ahead of the Federal Reserve’s own policy update.
The Bank of Japan is the only major central bank that hasn’t hiked borrowing costs during the current cycle, choosing instead to keep its main policy rate at minus 0.1% since 2016. It’s also relied on yield-curve control for years to ensure monetary policy remains loose, by containing short- and long-term interest rates. Like its counterpart in the U.S., the BOJ has a 2% target on inflation and has watched recent price gains come in above forecasts.
But Japan’s central bank is poised to leave behind its era of negative interest rates next week, Nikkei Asia reported Friday, without citing its sources. The publication said the plan is to move the country’s policy rate up to between 0% and 0.1%, marking the BOJ’s first rate hike since February 2007.
Overnight, Japan’s largest labor organization, Rengo, confirmed that wage negotiations have produced a preliminary average pay increase for workers of 5.28%, the largest gain in more than 30 years. Meanwhile, market participants mapped out the array of possible outcomes that could come from the BOJ’s two-day meeting.
A decision by the BOJ on Tuesday to lift rates to zero via a 10-basis-point move should trigger a mild market reaction, according to W. Brad Bechtel, global head of FX at Jefferies in New York. However, a bigger 20-basis-point hike that takes rates to 0.1% “might trigger a more violent market reaction that could see risk assets sell off and the [yen] strengthen, for a more protracted time frame,” Bechtel wrote in a note on Friday.
Ultimately, the BOJ “is not going to hike much beyond three or so hikes anyway, maybe into the 30-50bps zone by year-end,” he said. If Japan’s policy makers are forced to hike faster than that because of the situation on the ground, Bechtel added, “then markets would start to destabilize, but I think we have to watch the data first to see if that starts to materialize and that risk is down the road by at least four or five months.”
Last July, efforts by the BOJ to tweak its approach to yield-curve control, by switching to a more flexible policy, sparked a selloff in the U.S. bond market and strengthened the yen even before any official action was taken. Japan officials have been considering scrapping their yield-curve control program for at least a year.
Denmark’s Danske Bank is standing by its strategically bullish view on the yen this year. In a Friday note, Danske analysts Bjørn Tangaa Sillemann and Mohamad Al-Saraf said that even if BOJ officials end up taking no action on Tuesday, as Danske Bank expects, they are likely to telegraph that a move is coming in April.
A nation’s currency tends to move in the direction of its interest rates and where they are relative to borrowing costs in other countries. The yen has depreciated roughly 20% against the dollar over the past two years, and its weakness has also prompted talk about the possible need for intervention.
The BOJ “is almost ready to hike the interest rate to zero and dismantle yield-curve control,” Sillemann and Al-Saraf wrote. “However, we see no reason to rush and expect them to stay on hold at the March meeting ending Tuesday, but it is admittedly a close call.”
On Friday, all three major U.S. stock indexes finished lower again, with investors attuned to the possibility that the Fed may not cut U.S. rates three times this year, as many expected. Treasury yields ended slightly higher, a day after February’s hot U.S. producer-price index report pushed 10- and 30-year rates up by the most in a month.
“The view is that with the possibility of the first BOJ hike in roughly 17 years, there’s a window to hike before Japan’s economy slows further, just as the window to cut seems to have moved away for other central banks,” said Tom Nakamura, a currency strategist and co-head of fixed income at AGF Investments in Toronto, which managed $33.2 billion (CAD $45 billion) as of Feb. 29.
