Kazuo Ueda’s surprise nod for the Bank of Japan governorship has renewed the focus on market expectations for tighter monetary policy this year.
(Bloomberg) — Kazuo Ueda’s surprise nod for the Bank of Japan governorship has renewed the focus on market expectations for tighter monetary policy this year.
With the nomination for the top BOJ job set to be announced Tuesday, bond traders are wagering on a further tweak to yield curve control sooner rather than later and pricing in an end to negative rates around the middle of the year. Equity investors see a boost for bank shares from a rise in yields.
Here are some charts that sum up the expectations in Japan’s markets:
Yield Curve
Benchmark yields have been holding close to the BOJ’s 0.5% policy ceiling this month amid speculation that Governor Haruhiko Kuroda’s successor will have to either tweak or completely abandon the curve-control program amid rising inflation.
Ten-year overnight-indexed swaps have been trading more than 30 basis points above equivalent bond yields, pointing to bets the cap will be lifted. Both are still far below Japan’s core inflation rate, which surged to a four-decade high in December.
“Japan has a big inflation problem that many economists seem to be under-estimating,” Amir Anvarzadeh, a strategist at Asymmetric Advisors in Singapore, wrote in a note. “We feel Ueda will not be tied down to Kuroda’s false hopes that inflation is on its way down from this quarter and will tweak yield-curve control first and sooner than many believe.”
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End of Negative Rates
The BOJ’s negative-rate policy is also expected to be terminated under Ueda’s reign. Forward-dated swaps are pricing in a removal of this tool in July followed by a series of hikes in short-term interest rates.
Japan is the only country that still maintains its short-term policy rate below zero, according to data from the Bank for International Settlements. The European Central Bank exited its negative-rate policy in July, followed by its counterparts in Switzerland and Denmark in September.
A shift away from negative yields has implications for Japan’s T-bill market which could exacerbate any bond selloff.
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Bank Shares Advance
In the stock market, a gauge of Japanese bank shares has climbed close to a five-year high amid hopes for a policy shift. The capping of benchmark yields and Japan’s negative-rate policy have been a millstone on the sector’s profitability.
Yen Volatility
The yen has jumped more than 12% since the end of October, outperforming all of its Group-of-10 peers, thanks to a boost from the BOJ unexpectedly doubling its 10-year yield cap in December. Bets on a slowing of Federal Reserve rate hikes have also added to the currency tailwinds.
Three-month implied volatility for the Japanese currency has been elevated since October even as an equivalent gauge for the broader market declined, indicating that traders are on guard for another BOJ surprise.
Soaring Bond Purchases
Bets on an expected demise of yield-curve control and policy tightening overseas have necessitated an increase in central bank intervention to defend its yield cap. The BOJ bought a record ¥23.7 trillion ($180 billion) yen of government bonds in January.
With the central bank already owning half of Japan’s government bonds, the increased purchases are choking off trading and hurting market functioning — the very issue that the BOJ said prompted its policy tweak in December.
The fragile state of the bond market provides further evidence that Kuroda’s unprecedented quantitative easing may have only a limited time left.
“Kuroda’s BOJ has challenged the limit of monetary policy and revealed its ineffectiveness,” Daisuke Karakama, chief market economist at Mizuho Bank Ltd., wrote in a note.
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