Investors are bracing for Wednesday’s Bank of Japan monetary policy decision, which has the potential to send tremors across local and global markets.
(Bloomberg) — Investors are bracing for Wednesday’s Bank of Japan monetary policy decision, which has the potential to send tremors across local and global markets.
While economists are near unanimous in predicting the BOJ will maintain its policy settings, their conviction has been waning since the central bank’s surprise move in December to raise its cap on bond yields.
The tension is showing up in financial markets to such an extent that even an unchanged decision stands to trigger a sharp reaction — Japan’s 10-year bond yield has repeatedly exceeded the BOJ’s 0.5% ceiling in recent days and implied volatility in currency markets is the highest since the pandemic.
Were the BOJ to relent to market pressure and abandon its yield-curve-control policy altogether, bonds would likely plummet, pushing rates higher and turbo-charging a yen rally, strategists say. Moves in the aftermath of the December decision — which sent Treasuries lower and touched everything from US equity futures to the Australian dollar and gold — show the impact may run beyond Japan’s markets even if the BOJ makes a smaller policy shift.
The yen has been rallying since October, reaching the strongest levels since May, on bets that an eventual end to so-called YCC will narrow Japan’s yield differential with other major economies. Further gains may be in store, especially as the dollar-yen currency pair has recently formed a death-cross pattern.
Yen volatility has jumped even further. One-week, at-the-money options implied volatility on the USD/JPY pair has climbed to the highest since the global outbreak of the pandemic in March 2020.
Japan’s bond market has been battling against the yield cap ever since it was implemented in 2016, with the challenge intensifying in recent days. The BOJ surprised markets last month by doubling the width of its YCC band, and claimed it did so to improve market functioning. In the end, it has had almost the opposite outcome. Traders rapidly pushed yields up through the top of the new ceiling.
The challenge set down by bond bears has spurred the BOJ to boost its daily debt purchases to a series of records, draining further liquidity from the market it was seeking to improve.
One downside of the record bond purchases is the increasing threat of another blow out in the popular bonds-futures basis trade. The BOJ has lent out a record amount of bonds on its balance sheet to try and narrow the difference between the prices of cash bonds and futures.
NOTE: Ernest Tsang is a markets producer for Bloomberg TV. The above observations are his own and not intended as investment advice. For more markets analysis, see the MLIV blog.
–With assistance from Cormac Mullen.
(Adds context around the BOJ decision in third paragraph)
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