Don't Be Afraid Of The Bank Of Japan

Written on 07/28/2023
Team UCapital 24

There is no need to fear the Bank of Japan. In 2015 the market was surprised when the EUR/CHF peg broke, resulting in a significant VaR shock. However, this time around, the market has been anticipating the end of yield curve control for over a year. As a result, risk sentiment will likely return once the YCC adjustment has passed.

"The best trade is long JPY or short JGB. So extreme is the market's Japanese government bond underweight that it is reported that at one time, BoJ may own more than 100% of some benchmark 10-year JGBs. Not only has the central bank bought the entire stock of bonds, it has lent it out to short-sellers who have sold it back to the BoJ," SPI Asset Management analyst Stephen Innes said.

It has been observed that Japanese investors have allocated a very small amount of their investments to Japanese Government Bonds (JGB), which is close to an all-time low. It's worth noting that Japanese investors have already sold a significant amount of foreign fixed income and have cash in dollars and foreign currencies that are waiting to be invested.

"This means that Japanese investors are currently underweight in JGB and JPY. As a result, there is a high possibility of a significant flow of funds being repatriated back into JPY and invested in fixed income. This may lead to a persistent demand for JGB and JPY as Japanese yields continue to stabilize."

Please remember that discontinuing or altering Yield Curve Control (YCC) is the starting point. It's important not to assume that removing YCC will signify the end of Japan's monetary policy adjustment. The subsequent step will be to prepare for the conclusion of negative rates.

"As Japanese investors make a comeback, the Bank of Japan will need to consider implementing Quantitative Tightening to meet market demands. These factors are expected to positively impact the currency more than the current adjustment to back-end yields. Along with other positive developments for the JPY, the direction for yen strength is strong, regardless of any short-term fluctuations."

The debate begins as to whether the BOJ will be able to tighten in this cycle while the global economy slows down. The US, EUR area, and China do not seem to be strong drivers of global growth next year. It is uncertain whether the BOJ will achieve the minimum goal of positive short-term rates during this global hiking cycle to establish policy normalcy.