Trigger-happy traders drive up yen, mistake tweaking for policy shift
- The yen has rallied across the board on BOJ tapering rumours
- But policy tweaks, if any, would be held back for January 23 meeting
- Eurodollar futures suggest markets falling into line with FOMC rate projections
By Max McKegg
The Bank of Japan is in regular contact with dealers in the government bond market advising them of bond buying plans as part of its yield-curve-control policy, targeted at holding the return on the 10-year maturity at “about zero percent”. On Wednesday the bank informed the market that, in a purely tactical move, it would slightly reduce the amount of long-dated bonds to be purchased on the day.
This seems to have caused great excitement among FX traders who pushed JPY higher across the board on the basis that this signalled a tapering of the BOJ’s quantitative easing program. The move is also being cited as a reason the US 10-year Treasury bond yield rose over 2.5%, thus kicking off a “bear market” according to some excitable analysts.
Cooler heads will notice the BOJ meeting set down for January 22-23 at which updated economic and price forecasts will be presented. If there is to be any change to monetary policy, that is the time it will be flagged. Any “signals” beforehand are an illusion.
The FX move means that the strong correlation between USDJPY and the US 10-year bond yield, already weakening over recent weeks, appears to have broken altogether, as shown in this weekly chart (click to enlarge).
However, traders have jumped the gun. The BOJ did give any signal when fine tuning its bond buying operations. The policy making board meets on January 22-23, and afterwards will issue its monthly Statement on Monetary Policy, the wording of which hardly changed at all last year. Governor Haruhiko Kuroda recently summarised his position as “there is still a long way to go to achieve the price stability target of 2%. Given this situation, the Bank will persistently pursue powerful monetary easing......”
That doesn’t sound like a man who would be taking his foot off the accelerator any time soon.
Nevertheless, the governor is only one of nine board members and the upcoming meeting coincides with release of the quarterly Outlook for Economic Activity and Prices, where each participant submits forecasts. If there has been any change in sentiment among the board as a whole it will show up in the “dot plot” of GDP growth and inflation projections.
With the unemployment rate at a multi-decade low of 2.7% and the output gap closed, conditions are in place for an uptick in inflation but there is no sign of it yet. As the following chart shows, the annual headline rate may have crawled up to 0.9% but is mostly due to energy price effects. The core rate (all items except fresh food and energy), which can be viewed as “home grown” inflation, continues to languish not much above zero.
Japan CPI chart
Source: Pictet Wealth Management
In its October 2017 forecasts the BoJ projected headline inflation of 1.4% over fiscal 2018 and 1.8% the year after. Oil prices have risen since then and economic growth is rising steadily, but it’s unlikely the January 23 update will raise these projections by more than 0.1%. Besides, the official line is that “powerful monetary easing” will continue until the observed rate of inflation - not the forecast - exceeds 2%, the so-called “inflation over-shooting” commitment.
A minor upward adjustment to the inflation forecasts, based mainly on energy price effects, is unlikely to convince the BoJ to change the current yield-curve-control co-ordinates of negative 0.10% for the policy rate and “around zero percent” for the 10-year JGB.
As the following chart shows (click to enlarge) the bank has stepped in on previous occasions when the yield had threatened to rise over 0.10%. When you own over 40% of the market –as the BoJ does – you get to call the shots (and they don’t lend out their holdings to hedge funds to short against them)
Japan government bonds chart
While the rally in JPY this week was premature it would be justified perhaps if the January 23 statement resolves the apparent conflict between the BoJ’s commitment to expand the monetary base (mainly via bond purchases) at an annual pace of ¥80 trillion while at the same time holding the 10-year JGB yield around zero percent. In other words, trying to control both volume and price at the same time.
The market is guessing the bank will place more emphasis on the price (yield) component.
Meanwhile, on the other side of the USDJPY cross, the probability of the FOMC pressing ahead with another rate rise in March is 68%, based on pricing of fed funds futures. Also, slowly but surely the market is coming around to the idea there will be three moves in 2018, with a 15% chance of four.
Chartists will have noted sentiment changing accordingly in the Eurodollar futures market. This chart shows a complex head and shoulders pattern in the December 2021 contract (click to enlarge). Friday’s CPI report out of the US could give this move some momentum.
Traders bidding up JPY on the back of fine tuning by the Bank of Japan this week have jumped the gun. Any tweaking of monetary policy – via adjustment to the yield curve control parameters – would be announced on January 23 after the board considers updated economic projections.
That’s possible, but not probable. Any “signals” being picked up ahead of then are based on wishful thinking.
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– Edited by Robert Ryan
Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.