MARKETS are reckoning with the very real chance that the Bank of Japan (BOJ) will end the world’s last remaining negative-rate regime and increase borrowing costs as soon as this month.
It’s a pivotal moment for global funds that have been pouring money into Japanese assets on bets of an economic renaissance, and for domestic investors who have been chasing better returns abroad after decades of disappointment at home.
The yen surged more than 2 per cent last week, its best run since the start of the year, amid signs that the BOJ sees a sustainable cycle of rising prices and wages taking hold. With labour unions making the strongest pay demands since the early 1990s, and reports that some central bank officials are in favour of a rate increase on Mar 19, bond yields have also climbed, as have shares of financial institutions, which stand to benefit from higher borrowing costs.
“Could consumer and domestic investor mentality undergo a sea change if their outlook for domestic assets improves materially? I think it would,” said Paresh Upadhyaya, director of fixed income and currency strategy at Amundi Asset Management. “It could potentially unlock the animal spirits to help lift the economy higher through higher investments.”
The markets have to adjust to that as hedge funds have been growing their bets against the yen to the highest in six years – making only marginal changes to those bets during the week through Mar 5, which was before the latest rate-hike chatter.
“Perhaps, Japan is finally coming out of this deflationary vortex and that could have profound implications on Japanese assets,” Upadhyaya said, explaining that this will be supportive for the yen through repatriation flows, mainly going into stocks.
The repricing of rate-hike bets has been particularly aggressive. The yen jumped late in the Asia on Friday (Mar 8) after Reuters reported a growing number of BOJ policymakers are leaning towards ending negative interest rates this month, citing four people familiar with the matter.
Benchmark 10-year Japanese government bond yields have risen, while overnight indexed swaps, which had the odds of a rate hike by Mar 19 at around 30 per cent last Friday, surged to over 80 per cent at one point. Currency traders have lowered their wagers against the yen by 5,058 contracts to 78,504 in the week through Mar 5, still very close to the highest level since 2018 that was reached a week earlier.
“There is a risk of an unwind,” said Nathan Thooft, global chief investment officer for the multi-asset solutions team and senior portfolio manager for Manulife Investment Management. “Most of our exposure is through our overweight to Japanese equities, which previously we had been hedging the currency, but now the position is unhedged.”
The yen can appreciate to as much as 140 to the US dollar as investors rush to get out of bets against it, Thooft said, while noting that he doesn’t expect “major” strengthening for the Japanese currency. It hit a one-month high of 146.88 on Friday.
The yen has been a popular funding currency for carry trades, with investors shorting it against higher-yielding counterparts. A BOJ policy shift is likely to put a dent in its funding appeal.
To be sure, the interest rate differential between Japan’s policy rate and that of other central banks will still be wide if negative rates end this month. But peers like the Federal Reserve may make multiple rate cuts this year. And the European Central Bank has indicated policymakers may be in a position to lower interest rates in June after they kept the rates unchanged on Thursday.
“Our bet is long yen, but that is a view that relies on our economists’ call for 125 basis points of easing by the Fed starting from June,” said Francesco Pesole, FX strategist at ING Bank in London. “There is a risk of overestimating the BOJ effect,” Pesole added.
Mike Schumacher, head of macro strategy at Wells Fargo Securities, said that the BOJ going from -0.1 per cent to zero would be a small event that the market has been getting ready for. The “decent possibility” of it subsequently hiking to 0.25 per cent would have much more impact, according to Schumacher.
“We expect the yen to strengthen over the course of 2024,” he said. “However, the moves probably will be uneven.” BLOOMBERG
