Speculation on BOJ policy change is increasing, but the market expects no change in current policy settings
Thank you for reading this post, don't forget to subscribe!The BOJ’s ultra-loose monetary policy is putting pressure on Japan’s financial markets. The 10Y JGB yield is hovering around 0.85% while USD/JPY has broken the important 150 level just this morning. The BOJ has run an unscheduled bond operation and offered a trillion yen of 5Y loans to commercial banks to keep yields low, while FX officials continue to warn FX market participants that they will intervene if necessary.
The weaker yen is putting more pressure on inflation, which will ultimately hurt consumption, and a sharp rise in rates is likely to hurt business investment. Meanwhile, increased bond purchasing operations will put more burden on the BOJ.
However, the central bank is still unwilling to abandon its negative yield policy, as the necessary conditions for such action (discussed later) have not been met. YCC policy faces major challenges, although higher long-term trends are strengthening globally. Thus, we expect the BOJ’s bond purchasing operations to increase, with the aim of slowing the pace of rate increases in the near future.
However, if the BoJ leaves current policy settings unchanged, financial markets could move in the opposite direction to the BoJ’s wishes, and the economic recovery could falter, especially with growing concerns of a global economic recession. Also, a fresh outlook report will also be released on the same day, which may support a policy change. However, if the BOJ misses the opportunity next week, it leaves open the possibility of taking such a decision at its December meeting. By then, the FOMC decision will have been announced and the impact of the policy action may be even greater at a time when market volumes will be lower at the end of the year.
BoJ may change 10Y JGB target
We believe ending the YCC policy is too radical for the BoJ and the central bank will likely maintain the existing 1% flexibility limit. In light of Governor Kazuo Ueda’s comments at the last meeting that the appropriate level for the 10Y JGB is below 1%, the BoJ is unlikely to take the 1% threshold any higher.
Instead, it is possible that the BoJ could raise its 10Y JGB target from the current level of around 0% to 0.25% or 0.5% (the current formal upper limit of the 10Y JGB) to reflect current market conditions. Bringing the main year of yield to 5Y from the current 10Y is also a possible option. Or the BOJ could change its forward guidance. It would be more effective to signal to the market that the BOJ is gradually moving towards normalization. If such changes come along with a higher outlook for inflation in FY23 and beyond, it will send a clear signal to the market.
BOJ’s quarterly forecast will indicate timing of policy normalization
Even if the Bank of Japan makes no policy changes, the market will keep a close eye on how the central bank’s growth and inflation outlook changes, and this could still be a market-moving event as it comes about. Can give a hint. Future policy moves.
Since the release of the quarterly projection in July, both growth and inflation have exceeded the BOJ’s forecasts. Annual FY23 GDP is expected to advance significantly to around 1.9% (vs. 1.3% in July forecast and 1.8% market consensus), as GDP growth in the first half of the year was stronger than expected Is. Yet FY24/25 GDP forecasts are expected to be little changed due to intensification of global headwinds.
The market’s focus will be on the inflation outlook as the BoJ aims to meet the permanent 2% price target, a key prerequisite for rate action. We believe the core CPI excluding fresh food for FY23 will be dramatically upgraded to around 2.9% (versus 2.5% in the July forecast and 2.7% market consensus). Energy prices had risen even before the Israel-Hamas conflict began, and service prices rose more than the BoJ expected. The energy subsidy program is likely to be extended until April next year, but inflation is likely to remain above 2%. More importantly, we expect the BoJ to raise its FY24 core CPI forecast to around 2.1% (1.9% in the July forecast and 1.9% market consensus), incorporating the recent rise in global commodity prices. Moreover, inflation is likely to rise temporarily above 3% in February due to base effects related to energy subsidy programs. In our own estimates, core CPI excluding fresh food is likely to remain above 2% for almost all of 2024.
As argued in our previous report, we believe three conditions must be met for the BOJ to take policy action. (1) Inflation above 2%, (2) wage growth around 3%, and (3) positive GDP output gap. We still think 2Q24 should be the right time for the BoJ’s first-class action. Inflation is likely to remain above 2% in the first half of 2024. The outcome of the major wage talks should be positive – given that the largest labor union, RENGO, is demanding at least a 5% wage increase for FY2014, and government policies that would support wage increases. Finally, we believe the negative output gap will close by the end of 2023 at the earliest.
The market is eyeing the latest outlook report
Source: Bank of Japan, Bloomberg, ING Estimates
There will be discussion on income tax cut soon
Prime Minister Fumio Kishida said earlier this week that his Cabinet was preparing a new economic stimulus package, including a temporary income tax cut for households and tax breaks for businesses. However, details of the tax cut proposal have not been revealed yet. We do not expect this impact to be included in next week’s BOJ Outlook and we think Governor Ueda is unlikely to comment on it at the press conference.
USD/JPY: It’s quiet, very quiet
Somewhat surprisingly – despite everything going on in the world, including horrors in the Middle East and fluctuations in US bond markets – the USD/JPY has spent the month of October flat-lining very close to 150. Realized that volatility has fallen to the lowest level since January 2022 and it is not clear why.
It may well be that heavy FX options positions in the 149-150 area (there are many large options expiring between October 27-30) combining with the threat of imminent FX intervention to eliminate volatility from USD/JPY. Still working.
On the topic of FX interventions, October 31st should be the day the Finance Ministry announces the FX intervention figures for October. For example, did the BoJ sell dollars on October 3 when USD/JPY fell to 147.50 intra-day? The case against intervention is that there has been no follow-through selling on the part of the BOJ and intervention has not been confirmed. The case for intervention is comments from Japanese officials suggesting that intervention would not be immediately confirmed, as well as the fact that on one day last year USD/JPY traded decisively above 150, the BOJ issued the same Sales of $37 billion were made in the day.
Last year, Japanese authorities were incredibly successful in their FX intervention as the broader dollar trend eased in October/November as evidence of US disinflation emerged and China made a U-turn on Covid restrictions. Like the Chinese authorities with USD/CNY at 7.30, it now looks like the Japanese are sticking to the defense of USD/JPY at 150 and praying that the broader dollar trend subsides.
Japan has not yet confirmed any FX interventions this year
Source: ING, Japanese Ministry of Finance
However, as noted above, there are no immediate signs of a change in the broader dollar trend, we think the prospects for a change in YCC policy are low. And those new macro forecasts will be big market drivers, with any FY25 CPI forecast close to 2% only adding to speculation about an exit from the BoJ’s ultra-loose policy. Given these major events on October 31, we think the risks are tilted to the downside for spot USD/JPY.
Yet investors are taking a more ambiguous view on the direction of the break-out by buying so-called butterfly options – that is, selling the chances of USD/JPY finishing near 150 and buying the chances of USD/JPY ending at or below 152. 146.50 (10 delta option) in a week’s time. This makes sense given the key USD/JPY bullish trend. Yet expectations of any YCC change seem relatively modest, as 10-year JGB yields (now 0.85%) are priced in the forward market at just 0.93% and 0.98% over three and six months respectively.
One week, the cost of 10 Delta Butterfly options is increasing
Source: Refinitiv, ING
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Source: think.ing.com
