The last central bank standing firm on its position is the Bank of Japan (BOJ). At a time when major central banks in the world race to tighten financial conditions, the BOJ’s strategy differs.
Not only that it does not tighten, but it keeps easing financial conditions.
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BOJ’s position was the best driver in the JPY pairs this year. As a result, all JPY pairs advanced, showing a sharp depreciation of the local currency, the yen.
Take the USD/JPY, for example. It traded above 135 this week before correcting a big as profit-taking ahead of tomorrow’s BOJ decision triggered a move lower.
So what will the BOJ do tomorrow? Will it cave to global pressures and announce a hawkish shift? Or will it hold its yield curve control policy unchanged, at the risk of another leg lower in the yen?
Here are two reasons why the yen’s slide might not be over (yet):
- BOJ must keep easing as global yields are rising
- Yen decoupled from equities
BOJ must ease more in response to rising global yields
Japan’s yield curve control or YCC program means that the BOJ is actively involved in the bond market. It tries to cap the yields from rising, and it does so by buying bonds.
Because of the inverse relationship between the price of bonds and yields, bond-buying from the BOJ triggers a decline in yields as a response. Hence, lower yields keep financial conditions easy in Japan.
But global yields are on the rise. All major central banks have already started a new tightening cycle. Only this week, the Fed hiked by 75bp and plans to hike more in July.
Also, the Bank of England set the bank rate at 1.25% today. Even the Swiss National Bank raised the rates from a historical low of -0.75% to -0.25%.
All these moves led to rising global yields, so the Japanese yields rise in sympathy, making the Bank of Japan’s task extremely difficult.
Therefore, if the BOJ is to keep the YCC in place, as it vowed, then it should ease more as more tightening comes from other central banks. Hence, the vicious circle should weigh on the local currency, the Japanese yen.
The yen decoupled from equities
Up until this year, the yen acted as a safe-haven currency. More precisely, it moved in a direct correlation with stocks – particularly with US stocks.
US stocks have corrected sharply this year. Nasdaq is down over 30%, and even the S&P 500 is in bear market territory. Yet, the yen declined instead of appreciating against the US dollar.
Is the yen’s slide toward 150 inevitable?
The yen decline looks like an uncontrolled movement. The USD/JPY is the one to reflect it perfectly – it moved from close to 100 to over 135 in a little over one year.
Such moves in the exchange rate are undesirable but are explained by the sharp divergence between the two central banks’ policies.
What are the risks going into tomorrow’s announcement?
A major risk for USD/JPY bulls is that the BOJ pivots. Or caves to pressures from his peers.
All central banks announcing their monetary policy decisions in the last couple of weeks have hawkishly surprised. It certainly feels that there is a concerted move.
If that is the case, then there is a risk that the BOJ will alter its current policy and become more hawkish. After all, even the Swiss National Bank hiked today after 15 years of keeping the interest rate at record lows.
The fear that the BOJ might be on the verge of pivoting explains today’s drop in the USD/JPY exchange rate. Or, it may be just profit-taking after such a sharp rally as the one seen in the last couple of weeks.
All in all, the JPY pairs remain bid and trade close to their recent highs. Should the BOJ’s decision be only mildly hawkish, or not at all, then there is scope for more advances and, why not, for the 150 level to be tested sooner rather than later.
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