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March 28, 2024

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Bank of Japan to surprise stock markets again?

Bank of Japan to surprise stock markets again?

It’s happening! After warning readers throughout 2022 that the Bank of Japan is the most important central bank to be following, and that the Bank of Japan matters, markets and traders are beginning to now realize how important this central bank is.

We have seen the Japanese Yen get slammed in 2022 as Japan kept interest rates in the negative as all other central banks raised interest rates. Even Europe and Switzerland raised rates out of negative territory. Based on interest rate differentials, the Yen was the clear loser and depreciated.

But now the Bank of Japan might be fighting back.

If you want a refresher, I recommend you read my older articles titled, “Why the Bank of Japan is the most important central bank“, and “Yensanity! Why the Bank of Japan matters!“.

Or, check out this Youtube video I recorded last year. It may be old but it is still relevant:

 

During the week of December 20th 2022, the Bank of Japan shocked all. The stock markets, the bond markets, traders, and analysts.

After a few months of doubling down on dovish policy which included:

  • The short-term policy interest rate: The Bank will apply a negative interest rate of minus 0.1 percent to the Policy-Rate Balances in current accounts held by financial institutions at the Bank.
  • The long-term interest rate: The Bank will purchase a necessary amount of Japanese government bonds (JGBs) without setting an upper limit so that 10-year JGB yields will remain at around zero
    percent.
  • In order to implement the above guideline for market operations, the Bank will offer to purchase 10-year JGBs at 0.25 percent every business day through fixed-rate purchase operations, unless it is highly likely that no bids will be submitted.

 

So unlimited printing of Yen to buy unlimited Japanese Government Bonds (JGBs) in order to keep the 10 year yield under 0.25%.

During that crazy December 2022 week, the Bank of Japan shifted and tweaked its yield curve control policy to allow Japanese 10 year bond yields to move 50 basis points either side of the 0% target. In other words, the 0.25% peg was moved higher.

The Bank of Japan said it is intended to “improve market functioning and encourage a smoother formation of the entire yield curve, while maintaining accommodative financial conditions“. This move sparked a sell-off in bonds and stock markets around the world.

This is how JGB yields moved post BoJ announcement:

TradingView Chart

A major spike sending yields higher, the Yen strengthened and global stock markets fell. Global yields rose.

So why does this all, and the Bank of Japan matter?

The previous move was a surprise. With BoJ Governor Kuroda set to step down in April 2023, nobody was expecting major changes to monetary policy. The thinking was there would be no policy change until the new Governor takes up the position. With the BoJ acting before the new Governor appointment, it tells us how serious things are getting. The Yen got too weak, and inflation is still persistent.

The most important reason why the BoJ matters is because they are the number 1 buyer of US debt. It is not China, but Japan. Since interest rates have been low in Japan for decades, Japanese wealth has been looking overseas for yield. They have been buying up safe US and European debt. In a way, Japanese money has inadvertently done yield curve control for the US and Europe, keeping rates low.

But with the BoJ adjusting the yield on the 10 year JGB, Japanese money may sell off US and European debt and return home. But interest rates aren’t high yet? Well inflation has been low in Japan for decades, and current inflation is from supply chain disruptions. We are not even seeing wages increase which would add inflationary pressures. The domestic Japanese investor may take this yield and the safety of having money in the country rather than overseas.

Plus, with a weaker Yen, it might make more sense buying Yen denominated assets than having to fork over more for US and European debt. Japanese savers could be bringing a big chunk of their savings back home and sell US and European debt. This will cause yields in the US and Europe to spike.

 

So what am I watching for this week?

Well, take a look at the current JGB 10 year yield chart:

TradingView Chart

As you can see, there is some trouble. Yields have risen above 0.50% which has caused the BoJ to print Yen and buy up JGBs to keep rates low.

But yields continue to remain above 0.50%. This is what the BoJ had to do:

But it did not end there! Just one day later, the BoJ set a NEW single day record w/ ¥5t of JGBs bought.

Remember, all of this is to defend the 0.50% on the 10 year JGB.

With the BoJ having to intervene and spend tons of Yen to buy up bonds, traders are betting on another BoJ surprise this week. Possible another tweak to their yield curve policy which may see yields drift higher to say 0.75%.

Once again, this move would be huge for financial markets. The most extreme case is that yields globally would rise so much that it would force central banks such as the Fed to step back in to buy bonds to keep the 10 year yield from rising in the US. This would mean a move back to QE… reversing the decision to sell off the balance sheet, and having to do so while raising interest rates and keeping them high for a long time to tame inflation.

TradingView Chart

The Japanese Yen is beginning to rise, and forex traders saw big Yen moves on Yen pairs. Traders would be buying Yen in anticipation of a BoJ surprise.

In summary, the Bank of Japan is important! This is apparent given the movement in global stock and bond markets after a policy tweak. Another tweak could be on the way which means more market volatility.

The evening of December 17th 2022 is when we should expect to hear from the Bank of Japan.

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