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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Macro Insights: Bank of Japan meeting playbook – bracing for volatility
Charu Chanana
Chief Investment Strategist
Summary: The highly-watched Bank of Japan policy decision due Wednesday has spooked tremendous volatility and warrants a cautious stance. But whether we see further policy tweaks this week or not, speculation for BOJ to remove its yield curve control will likely to build into BOJ chief nominations due February 10, spring wage negotiation in March and a change of hands at the helm in April.
There is a lot at stake with regards to the upcoming Bank of Japan decision on January 18. Quiet unusual for those who have spent years covering Japan macro and realize how it was so easy to miss headlines from BOJ meetings previously.
But with the implied volatility in overnight USDJPY options at over 50%, the highest levels since 2016 (see Chart below), all eyes will be glued to the BOJ announcements this week. USDJPY traded to lows of 127.23 on Monday before rising back towards 129 on Tuesday morning – all this despite the US bond markets being closed on Monday. Enough reason to believe that the focus for the Japanese yen has moved to domestic events, rather than being a pure play of yield differentials.
Why BOJ could further tweak its policy this week?
- The surprise December move to shift the ceiling of the trading band for 10-year Japanese government bonds from 0.25% to 0.5% was the first step to removing massive stimulus
- Bond yields have since tested the new cap, and breached it for the last three consecutive days prompting the BOJ to announce unscheduled bond buying worth over 10 trillion yen.
- A local media report last week also said that the central bank will evaluate the side effects of its massive monetary policy easing, which fuelled further speculation that another policy tweak may be on the cards.
- December Tokyo CPI touched 4% levels and the latest PPI numbers have risen to double digits at 10.2% YoY, suggesting Japan’s inflation has not yet started to cool
- Increasing case of a global soft-landing would likely continue to support Japan’s exports and overall growth
But the BoJ loves to surprise the markets. With so much speculation built in for this week’s tweaks, officials may rather choose to wait to see the full impact of last month’s move before taking further action. But whether the BOJ announces a change this week or not, bears are unlikely to give up with Governor Kuroda set to retire in April and the next BOJ chief will likely be under pressure to exit negative rate policy before too long. That selection process could be taking place over the next month, with nominations likely by February 10. Hawkish names would spur further expectations that the BOJ will eventually end its YCC policy.
Thereafter, focus will shift to spring wage negotiations due in March. Many Japanese corporate, including Uniqlo owner Fast Retailing, Nippon Life Insurance and Suntory Holdings, have already announced wage hikes. BOJ Governor Kuroda continues to emphasise the need for wage growth in Japan to consider removing stimulus. Finally, the change of hands at the helm of the BOJ in April, with a new Governor and two new deputy Governors set to take charge, could further continue to fuel speculation of a policy shift.
So the direction of where this is headed seems correct, but the timing is uncertain. It may be worth considering a bearish outlook on Japan equities (JP225) and a positive outlook on Japanese banks (Topix Bank ETF), but the current volatility levels suggest a cautious stance may be warranted this week.
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