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Tokyo - As bond investors remain glued to their screens for the Bank of Japan’s (BoJ) policy review decision on Wednesday, Tokyo’s foreign-exchange traders may be looking to the Federal Reserve’s announcement hours later.
The yen is set for three straight quarters of gains, the longest rally since 2011, in the wake of the BOJ’s decision to leave its bond-buying program unchanged in July and to adopt negative rates in January.
Whether Governor Haruhiko Kuroda decides to widen the gap between long- and short-term yields, or cut rates, currency strategists say the biggest threat to the yen would be signs of hawkishness from Fed chair Janet Yellen. Over the past two years, Japan’s currency has a greater tendency to move with changes in US short-term yields than with those locally, data compiled by Bloomberg show.
“The message has been conveyed that the BOJ wants to steepen the long-end of the curve, but the baseline is the pace of US rate hikes, ” said Shinsuke Sato, head of the currency trading group at Sumitomo Mitsui Banking.
“The dollar’s uptrend won’t resume if the Fed’s rate hike pace is once a year. A steepening Japanese yield curve, whether or not the BOJ deepens the negative rate, won’t bring back the yen weakening trend.”
Japan’s currency has jumped 18% this year, the best performance among Group-of-10 peers, amid speculation the BOJ is running out of policy ammunition in its quest to spur inflation through unprecedented monetary easing.
Kuroda’s decision to cut rates to minus 0.1% in January set off a rout in banking stocks and a flight to the yen as a haven. Gains in the yen accelerated at the end of July when the BOJ underwhelmed markets with stimulus measures that fell short of analysts’ expectations. The currency was at ¥101.76/$ at 08:25 on Tuesday.
The yen’s bull run paused last month as traders shifted their focus to prospects that the Fed will raise rates for the first time since December. Japan’s currency depreciated 1.3% in August, halting a two-month advance, as the market’s odds for a US rate increase in 2016 surged to exceed 60% after Yellen said at a symposium in Jackson Hole, Wyoming, that the case for tighter policy had strengthened.
The yen will end this year at ¥105/$, according to the median estimate of more than 60 analysts surveyed by Bloomberg, from a projection of 125 at the start of January. Deutsche Bank forecasts ¥94, JPMorgan estimates 103 and Bank of Tokyo-Mitsubishi UFJ is calling for ¥98. Sumitomo Mitsui Banking’s head of research, Yoichiro Yamaguchi, sees 105.
The yen and two-year Treasury yields - those that are among the most sensitive to monetary policy expectations - showed a correlation of about 0.5 over the past two years, data compiled by Bloomberg show. A 0 reading would indicate no link between the two while a 1 would indicate they move in lock-step. The yen and two-year Japanese yields had a correlation ratio of 0.08.
Heading into the BOJ and Fed policy meetings on Tuesday and Wednesday, options traders are showing a revival in bullish yen sentiment. The premium for contracts to buy the yen versus the dollar in one month, over the cost of those to sell, was at 0.65 on Tuesday, after largely disappearing at the end of August.
Speculators’ boosted net bets on gains in the Japanese currency to 56 846 contracts last week, close to the record high of 71 870 reached in April.
The yen could see modest gains should the BOJ cut rates, according to Tohru Sasaki, head of Japan markets research at JPMorgan Chase in Tokyo, and a former central bank official.
Just over half of economists surveyed by Bloomberg anticipate expanded easing this week, with a rate cut seen as the most likely option. Sasaki has been among the most accurate forecasters of the currency since 2013.
Negative rate
“Deepening the negative rate would not weaken the yen, but would do the reverse,” said Sasaki, who said such a policy wouldn’t be enough to break the currency out of its range from 100 to 104. “JPMorgan forecasts a deepening of the negative rate, but I personally think the BOJ would embark on the deeper negative-rate policy only in times of instability.”
Taisuke Tanaka, Deutsche Bank’s chief currency strategist and head of fixed-income research in Tokyo, said a BOJ decision to steepen the yield curve would only weaken the yen slightly.
“While giving some leeway to the BOJ’s policy, which is already seen as approaching a limit, the measure will not trigger a large-scale, sustainable yen weakening flow,” Tanaka said. “It may strengthen support for the ¥100 to ¥105 range temporarily, but the impact will be nothing more than that.”
