BoJ on hold but support for hike building

JPY: A shift toward hiking to help yen

The BoJ announced an unchanged monetary stance today as the policy rate was left at 0.50% but unexpectedly two policy members voted to lift the policy rate to 0.75%. Hajime Takata and Naoki Tamura are known as two of the most hawkish members but the dissents will certainly help reinforce expectations that the BoJ could decide to lift the key rate at the next meeting in October. The BoJ also took another important step toward the full normalisation of monetary policy by announcing a plan to cut its ETF and J-REIT holdings. In July the BoJ completed its sales of equities that had been previously bought for financial stability purposes and hence there had been some market speculation the BoJ could turn its attention to reducing ETF and J-REIT holdings. The pace of reduction is modest with the market value of annual sales of ETFs (JPY 620bn) and J-REITs (JPY 5.5bn) equating to 0.05% of trading value.

The yen has advanced primarily on the back of the two dissenting votes while the Topix Index fell a little over 1.0% after the announcement to the current intra-day low before recovering modestly. The gain for the yen has been relatively modest given Governor Ueda has only just begun speaking and market participants have viewed the statement as highlighting a continued level of caution. The statement was largely unchanged but for the description of corporate profits that remained at a high level “although downward effects due to tariffs have been seen in manufacturing”. The more positive momentum for the US dollar more broadly has curtailed the scale of drop in USD/JPY.

The statement also included the reference that it “remains highly uncertain how trade and other policies in each jurisdiction will evolve and how overseas economic activity and prices will react to them”. The BoJ would have to pay “due attention” to the impact on “financial and foreign exchange markets and on Japan’s economic activity and prices”. That does point to a BoJ that continues to see international uncertainties as a possible impediment to following through with another rate hike.

Still, we would argue that gradually conditions are falling into place and the dissents and the decisions to begin reducing holdings of ETFs and J-REITs point to building confidence that the outlook will not deteriorate. Trade policies will likely always remain a source of uncertainty but the fact that the US equity market and many global markets are at record highs points to scope to raise the key policy rate again.

That’s the way the rates market has viewed these dissents and even before Governor Ueda speaks yields at the front-end of the JGB curve have jumped. The OIS market now indicates 13bps of hikes priced for the October policy meeting, up from 8.5bps yesterday, implying a slightly greater than 50% probability of a 25bp hike. That seems reasonable given the LDP leadership election on 4th October is an element of uncertainty that could derail a hike on 30th October. Governor Ueda has just begun his press conference and he has repeated the key guidance that the BoJ will raise rates if the BoJ’s economic outlook is realised but his comments look balanced so far.

BOJ HOLDINGS OF ETFS AND J-REITS SET TO DECLINE

Source: Bloomberg, Macrobond & MUFG GMR

USD: Rebound for the dollar as curves steepen

The post-FOMC market fallout continues to be seen via higher US yields and a stronger US dollar. As we stated here on Wednesday, it was going to be difficult for the FOMC to out-dove market pricing going into the announcement and that’s how it unfolded after the meeting with OIS pricing for cuts the two final FOMC meetings of the year about 5-6bps short of two 25bp cuts, similar to the level prior to the FOMC meeting. More cuts were signalled but that signal coincided with a higher inflation forecast and a balanced press conference that gave a hawkish interpretation to the meeting that was really more a reflection of pricing than anything clearly hawkish.

The US 2s10s curve has been re-steepening of late (7bps in a week) but there was little further steepening yesterday – about 1bp. Curves did steepen much more dramatically outside of the US which coincided with further currency declines although the correlation between curve steepening move and FX is much more clear for the US than it is in either Germany or the UK.

It certainly could have played a role in GBP underperformance. The BoE’s MPC decision was as largely expected with OIS moves marginal and the front-end of the Gilt curve (2-year) unchanged. We covered this in an MPC review published yesterday (here). But the 30-year Gilt yield jumped 8bps and was the biggest daily increase in the 2s10s Gilt spread since 2nd July – a day when GBP/USD declined notably. The chart above highlights the correlation between the pound (TWI) and changes in the 2s10s Gilt yield spread that points to a negative FX performance.

We are somewhat surprised with the QT policy change and thought based on Governor Bailey’s comments that Gilt market conditions would play a role in the QT plan for the year ahead that the QT total would have been lower. At GBP 70bn it means that outright sales by the BoE will actually pick up from GBP 13bn in the current year to GBP 21bn. Yes, the BoE stated it would move up the curve to conduct the QT but surely the best way to take account of Gilt market conditions would have been to cease outright sale (so QT would have been GBP 49bn) or keep the outright sale steady (QT would have been GBP 62bn). We assumed GBP 60bn to show some reduction.

The 2s10s in Germany also increased, by 5bps yesterday. The driver in Germany of long-end moves higher has been more related to increased government spending related to defence and infrastructure and given Germany’s fiscal capacity is not a currency negative like in the UK. The same rolling correlation as in the chart above for German bunds and the euro is positive.

We would still view the FX link with curve moves as most reliable for the US. The Fed certainly look to have the most to do in terms of cutting rates while Fed independence risks should also reinforce curve steepening ahead. Historically curve steepening has coincided with dollar depreciation which should become clearer to see as the Fed embarks on further easing ahead.

ROLLING CORRELATION OF DAILY % GBP TWI PERFORMANCE & CHANGE IN 2S10S GILT YIELD SPREAD – STEEPER CURVE MEANS WEAKER GBP

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com