BoJ rate hike prospects increase on stronger data

JPY: Prospects of BoJ hike in December grows

The prospect of a BoJ rate hike in December continues to grow with the OIS implied probability now creeping above the 50% level. The data released today in Tokyo did nothing to alter the gradual increasing probability with Tokyo CPI data revealing a core annual rate of 2.8%, slightly higher than the market consensus. The weakness of the yen is helping lift inflation expectations with Japan’s 10-year breakeven rate trading just below 1.7%, matching the high from March this year, the highest in the series going back to 2004. The BoJ will also have more confidence on the outlook for the economy. Industrial output jumped by 1.4% MoM in October following a 2.6% gain in September. The market was expecting a decline of 0.6% in October. It was the largest two-month gain since July 2022. The consumer also increased spending with retail sales surging 1.6% MoM in October – that was the largest gain since August 2020 when the economy was rebounding from a covid hit.

Further stimulus is now on the way as well and today the government announced its plans for JGB issuance to cover the extra spending. The net extra spend in the JPY 21.3trn supplementary budget amounts to JPY 18.3trn and JPY 11.7trn of this will be covered by issuance of additional debt. In a step that will help support the long-end of the curve the issuance will focus on front-end tenors with t-bills, 2-year and 5-year JGBs taking the added issuance. There had been an expectation that the 10-year sector would also see added issuance. The announcement will likely see some curve flattening momentum in JGB trading next week.

Upward pressure on front-end yields is also more supportive for the yen than an issuance plan that encouraged curve steepening. The issuance plan along with the data released today and the rising probability of a BoJ rate hike in December should prove more supportive for the yen although there has been limited FX reaction today to the data and issuance announcement. FX volumes are bring impacted following the halting of trading on CME after a data centre issue. Today is also month-end and FX performance can often be determined by those less predictable flows. In a sign of growing expectations of a rate hike the 2-year JGB auction today was met with weaker demand – the bid-to-cover dropped notably from 4.35 to 3.53. There has been no BoJ communications today but we would expect rhetoric over the coming week to help increase expectations further on the prospect of a December rate hike. That could come on Monday when Governor Ueda will give a speech in Nagoya (01:05 GMT).

STRONGEST GAIN IN INDUSTRIAL PRODUCTION OVER 2MTHS SINCE JULY 2022 WILL SUPPORT SOONER BOJ HIKE

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Weekly flow data highlight record foreign investor buying of equities

The impact of change in political leadership has been clear in Japan with the yen notably weaker and JGB yields higher as market participants position for reflationist policies under the new leadership of Sanae Takaichi. The weekly cross border flow data was released earlier today by the MoF shows that the positive momentum in demand for Japanese equities by foreign investors is beginning to fade. That overall demand has helped propel a continued strong performance of Japanese equities. The Topix index from the close just prior to the confirmation of PM Takaichi’s victory has gained 8.0%. Over the same period the S&P 500 has advanced by a much more modest 1.4%. The MoF cross-border flow data today revealed that foreign investors sold JPY 349bn worth of Japanese equities in the week to last Friday. That was the second week of selling in the last three. Still, there has been strong buying in total since political change was apparent and covering the seven weeks to Friday 14^th November (from the week into the weekend of the leadership election) foreign investors have bought JPY 7,822bn worth of Japanese equities – that is in fact a record total over any seven-week period, underlining the impact the prospect of change in leadership and then PM Takaichi’s victory has been.

The considerable outperformance of Japanese equities (it’s the same vs European equities – over the same period since the weekend of Takaichi’s election victory the Euro Stoxx 600 is close to unchanged) means that hedge-related yen selling by foreign investors has likely picked up if those investors aim to maintain stable hedge ratios. The new inflows are also likely hedged to a high level given it still pays for a foreign investor to hedge their yen exposures, thus enhancing overall returns.

We suspect the scale of foreign investor demand may start to recede going forward. This week we have had the release of details on the fiscal stimulus package and this was indeed larger than expected at JPY 21.3trn versus a package of JPY 13.9trn a year ago. The government projects a very optimistic economic impact of a lift to annual GDP growth of 1.4% on average over a three-year period, totalling JPY 24trn. We suspect the impact will be a lot less, as is usually the case with stimulus packages.

In addition, foreign investor demand has likely been fuelled by the continued extreme caution from the BoJ in hiking rates. But the excessive yen weakness and communications from the BoJ suggest to us that the BoJ could indeed hike rates as soon as in December. So the record foreign investor demand could well be about to turn and if Japanese equities take a correction lower, some unwind of hedge-related yen short positions could follow. Making sure this is not too disruptive is probably why the BoJ is attempting to manage this cautiously with communications that subtly signal a shift in stance. Again, watch out for Governor Ueda’s speech on Monday.

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Source: Bloomberg & Investing.com