USDJPY surged on dovish BOJ exit but slipped after the Fed

On Tuesday (19th March), some focus of the market was also on BOJ after recent hawkish jawboning by BOJ/JP policymakers to exit NIRP (selective negative reverse repo rate) and YCC policy. As a result, USDJPY already stumbled from around 151 in mid-February to almost 146.50 in late February. But USDJPY also recovered to over 149.75 amid less hawkish BOJ and more hawkish Fed jawboning. BOJ almost made it clear that even after exiting the so-called NIRP (-0.10% selective reverse repo rate) and YCC stance, BOJ may not be in a hurry to increase the repo (interest) rate, which is presently at +0.30%, kept unchanged since 2016.

Japan’s Kishida Government is also under growing public pressure in recent times amid soaring core inflation and subdued wage growth. Although higher USDJPY is positive for Japan’s export-savvy economy, at the same time it’s causing significantly higher imported inflation as Japan is dependent on imported food & fuel/various commodities. Japan’s PM Kishida is now almost begging corporates/private sector to increase the salary of Japanese workers adequately/significantly to cool growing social unrest in Japan. BOJ decided to normalize its decade-old ‘super powerful’ monetary policy only after reports of higher wages agreed between Japanese corporates and labor unions.    

Although the market was expecting an earlier & deeper Fed rate cut of -150 bps from March/May’24, various Fed policymakers including Chair Powell are now carefully jawboning the market in a well-planned (co-ordinated) manner to control inflation expectations and also bond yields for the intended soft & safe landing of the Wall/Real street (economy) ahead of Nov’24 U.S. Presidential election.

The market is now expecting Fed rate cuts from June and also the start of QT tapering from June’24. But the Fed may start QT tapering from March’24 and close the same by June’24 before going for rate cuts from July’24 as the world’s most important central bank may not go for two contradictory policy actions (QT and rate cuts) at the same time.

As highly expected, on Tuesday BOJ kept all policy rates unchanged, except the special reverse repo rate on the complimentary deposit facility (CDF). The Bank of Japan (BOJ) hiked its key short-term special deposit facility (reverse repo) key policy rate unchanged to +0.1% from prior -0.1% (since Dec’16) by a 7-2 vote. At the same time, as highly expected BOJ kept its Basic Loan Rate (repo rate) unchanged at +0.3% (since Dec 2008), while encouraging the uncollateralized overnight call rate to remain at around 0.0 to 0.1%. The BOJ has ended the so-called 8-year-old super-powerful NIRP (negative reverse repo rate on CDF to encourage bank lending rather than disposing with BOJ). The BOJ also scrapped its YCC policy after gaining confidence about 2% inflation on a sustainable basis and an end of deflationary mindset.

In Japan, so-called core inflation (w/o fresh food, but includes fuel) had exceeded the central bank's 2% target in over a year while the big corporates/business houses had agreed to raise salaries by +5.28%, the biggest wage hike in over three decades. However, two of the BoJ’s nine board members, Nakamura and Noguchi, dissented. The central bank also terminated yield-curve-control (YCC) for 10-year government bonds (JGBs) and discontinued the purchases of ETF and Japan real estate investment trusts (J-REITs). Further, the BoJ will slowly reduce the pace of corporate bond buying before fully stopping it in about a year. Still, the bank added that in case of a rapid rise in long-term rates, it would make nimble responses, such as increasing the amount of JGB purchases; i.e. the BOJ will continue QE, not QQE

 

 

Full Text of BOJ statement of monetary policy: 19th March’2024

Changes in the Monetary Policy Framework

At the Monetary Policy Meeting held today, the Policy Board of the Bank of Japan assessed the virtuous cycle between wages and prices and judged it came in sight that the price stability target of 2 percent would be achieved sustainably and stably toward the end of the projection period of the January 2024 Outlook Report (Outlook for Economic Activity and Prices).

The Bank considers that the policy framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control and the negative interest rate policy to date have fulfilled their roles. With the price stability target of 2 percent, it will conduct monetary policy as appropriate, guiding the short-term interest rate as a primary policy tool, in response to developments in economic activity and prices as well as financial conditions from the perspective of sustainable and stable achievement of the target. Given the current outlook for economic activity and prices, the Bank anticipates that accommodative financial conditions will be maintained for the time being.

On this basis, the Bank made the following decisions, including that on the guideline for market operations:

·         The Bank judged that the inflation-overshooting commitment regarding the monetary base had fulfilled the conditions for its achievement

·         Guideline for market operations (a 7-2 majority vote):

·         The Bank decided to set the following guidelines for market operations for the intermeeting period.

·         The Bank will encourage the uncollateralized overnight call rate to remain at around 0 to 0.1 percent

·         In order to achieve this guideline, the Bank will apply an interest rate of 0.1 percent to current account balances held by financial institutions at the Bank (CDF-Complementary Deposit Facillity-excluding required reserve balances)

·         The new guideline for market operations and the new interest rate on the current account balances will be effective from March 21, 2024

·         Purchase of Japanese government bonds (JGBs) (an 8-1 majority vote)

·         The Bank will continue its JGB purchases with broadly the same amount as before

·         The amount of JGB purchases is currently about 6 trillion yen per month. The Bank will continue to announce the planned amount of JGB purchases with a range and will conduct the purchases while taking account of factors such as market developments and supply and demand conditions for JGBs

·         In case of a rapid rise in long-term interest rates, it will make nimble responses by, for example, increasing the amount of JGB purchases and conducting fixed-rate purchase operations of JGBs -- both of which can be done so regardless of the monthly schedule of JGB purchases-- and the Funds-Supplying Operations against Pooled Collateral

·         Asset purchases other than JGB purchases (a unanimous vote)

·         The Bank will discontinue purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs)

·         The Bank will gradually reduce the amount of purchases of CP and corporate bonds and will discontinue the purchases in about one year

·         Treatment of new loan disbursements under the Fund-Provisioning Measure to Stimulate Bank Lending etc. (a unanimous vote)

·         The Bank will provide loans under the Fund-Provisioning Measure to Stimulate Bank Lending, the Funds-Supplying Operation to Support Financial Institutions in Disaster Areas, and the Funds-Supplying Operations to Support Financing for Climate Change Responses with an interest rate of 0.1 percent and a duration of one year. About the Fund-Provisioning Measure to Stimulate Bank Lending, the maximum amount of funds that each eligible counterparty can borrow will be equivalent to the net increase in its amount outstanding of loans

·         Japan's economy has recovered moderately, although some weakness has been seen in part. Looking at the background conditions of wage developments, corporate profits have continued to improve and labor market conditions have been tight. In this situation, as indicated by the results of this year's annual spring labor-management wage negotiations to date, wages will likely continue to increase steadily this year, following the firm wage increase last year. Moreover, anecdotal information from firms -- which is gathered through the Bank's Head Office and branches -- suggests that a wide range of firms have maintained their stance of raising wages

·         On the price front, while the effects of a pass-through to consumer prices of cost increases led by the past rise in import prices have waned, services prices have continued to increase moderately, partly due to the moderate wage increases seen thus far. As these recent data and anecdotal information have gradually shown that the virtuous cycle between wages and prices has become more solid, the Bank judged it came in sight that the price stability target would be achieved sustainably and stably toward the end of the projection period of the January 2024 Outlook Report

Notes:

Voting for the action: UEDA Kazuo, HIMINO Ryozo, UCHIDA Shinichi, ADACHI Seiji, NAKAGAWA Junko, TAKATA Hajime, and TAMURA Naoki. Voting against the action: NAKAMURA Toyoaki and NOGUCHI Asahi.

While Nakamura Toyoaki was in favor of discontinuing purchases of ETFs and other assets, which were mainly related to large firms, he dissented, considering that the Bank should continue with the negative interest rate policy until it confirmed that the capacity of small and medium-sized firms -- whose recovery in business performance was delayed -- to raise wages would likely increase.

Noguchi Asahi dissented, considering that terminating the yield curve control framework and the negative interest rate policy simultaneously should be avoided from the perspective that the Bank should more carefully assess whether the virtuous cycle between wages and prices had become more solid and avoid the risk of bringing about discontinuous changes in financial conditions.

Voting for the action: UEDA Kazuo, HIMINO Ryozo, UCHIDA Shinichi, ADACHI Seiji, NOGUCHI Asahi, NAKAGAWA Junko, TAKATA Hajime, and TAMURA Naoki. Voting against the action: NAKAMURA Toyoaki. Nakamura Toyoaki dissented for the same reason as he opposed the proposal regarding the guidelines for market operations.

Economic Activity and Prices in Japan: Current Situation and Outlook:

Japan's economy has recovered moderately, although some weakness has been seen in part. The pace of recovery in overseas economies has slowed. Although exports have been affected by the developments in overseas economies, they have been more or less flat. Industrial production has been more or less flat as a trend, but it has declined recently, partly due to the effects of a suspension of production and shipment at some automakers.

With corporate profits improving, business fixed investment has been on a moderately increasing trend. The employment and income situation has improved moderately. Private consumption has been resilient, although the impact of price rises and developments such as a decline in automobile sales due to the suspension of shipment at some automakers have been observed. Housing investment has been relatively weak. Public investment has been more or less flat. Financial conditions have been accommodative.

On the price front, the negative contribution of energy prices to the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) has been relatively large, partly due to the government's economic measures. That said, the rate of increase in the CPI has been at around 2 percent recently, mainly on the back of the fact that, despite waning, the effects of a pass-through to consumer prices of cost increases led by the past rise in import prices have remained, and services prices have increased moderately. Inflation expectations have risen moderately.

Japan's economy is likely to continue recovering moderately for the time being, supported by factors such as the materialization of pent-up demand, although it is expected to be under downward pressure stemming from a slowdown in the pace of recovery in overseas economies. Thereafter, as a virtuous cycle from income to spending gradually intensifies, Japan's economy is projected to continue growing at a pace above its potential growth rate.

The year-on-year rate of increase in the CPI (all items less fresh food) is likely to be above 2 percent through fiscal 2024, due to factors such as the effects, albeit waning, of the pass-through to consumer prices of cost increases led by the past rise in import prices and a waning of the effects of the government's economic measures pushing down CPI inflation of the previous year. Thereafter, the rate of increase is projected to decelerate owing to the dissipation of these factors. Meanwhile, underlying CPI inflation is likely to increase gradually toward achieving the price stability target, as the output gap turns positive and as medium- to long-term inflation expectations and wage growth rise.

Concerning risks to the outlook, there are extremely high uncertainties surrounding Japan's economic activity and prices, including developments in overseas economic activity and prices, developments in commodity prices, and domestic firms' wage- and price-setting behavior. Under these circumstances, it is necessary to pay due attention to developments in financial and foreign exchange markets and their impact on Japan's economic activity and prices.

Highlights of BOJ MPC statement: 20th March’2024

·         BOJ Sets Policy Rate Range at 0% to 0.1%

·         BOJ Sets Policy Rate Range at 0% to 0.1%

·         BOJ raises interest rates (selective reverse repo) for the first time in over a decade

·         BOJ Changes Money Market Operations Guidelines in 7-2 Vote

·         BOJ decides on long-term JGB purchase with an 8-1 vote

·         BOJ Unanimously Decides on Asset Purchases Excluding Long-term JGBs

·         BOJ continues JGB purchases with a similar volume as before

·         BoJ scraps yield curve control (YCC)

·         BOJ Unanimously Decides Treatment of New Loan Disbursements Under Fund-Provisioning Measure to Stimulate Bank Lending

·         BoJ Board Member Nakamura and Noguchi dissent to decision on change in money market operations guideline

·         BOJ's Nakamura dissents from the decision on change in money market operations and agrees to end ETF buying mainly for big firms, but believes NIRP should continue until there is a chance of increased buying power for small firms

·         BOJ's Noguchi dissents from the decision to change money market operations, citing the need to examine strengthening the virtuous cycle of wages and prices

·         BoJ anticipates accommodative financial conditions for now

·         BOJ's Noguchi warns against discontinuous changes in monetary policy by eliminating YCC and NIRP together

·         BOJ's Nakamura votes against long-term JGB purchases due to similar concerns as with guidance on monetary market operations

·         BoJ to keep buying bonds (QE)

·         Japan's economy likely to continue moderate recovery

·         BoJ to gradually reduce the amount of purchases of CP and corporate bond

·         BoJ to buy 50 bln-100 bln yen of 25-plus Yr JGBS 2 times in April

·         YoY CPI increase likely to be above 2% through FY 2024

·         BoJ to apply 0.1% interest to all excess reserves parked with BoJ (under Reverse Repo)

·         There are extremely high uncertainties in Japan's economy, prices

·         Underlying CPI is likely to increase gradually toward achieving the price target

·         BoJ downgrades assessment of consumer spending and production

·         BOJ sees a moderate increase in inflation expectations

·         BOJ expects a gradual increase in underlying CPI inflation to achieve the price target

·         BOJ to continue announcing planned JGB buying with range and taking market developments into account for supply-demand conditions

·         BOJ notes resilient private consumption despite observed impacts of price rises and other factors

·         BOJ to closely monitor market and FX developments' impact on the economy

·         BOJ sees extreme uncertainties regarding Japan's economy and prices

·         BOJ to guide overnight call rate within 0% to 0.1% range

·         Japan's economy to continue growing at a pace above its potential growth rate

·         BOJ Adopts 0.1% Interest on Excess Reserves, Effective March 21 (Not March 31)

·         BOJ says the policy framework of QQE with YCC and NIRP fulfilled their roles

BOJ to Announce Planned Amount of JGB Purchases with Range, Will Conduct Buying while Considering Market Development, Supply, and Demand

Highlights of BOJ Governor Ueda’s comments: BOJ presser/Q&A: 20th March’2024

·         We don't have a preconceived notion of which would come first: reduction of bond buying or rate hikes

·         I cannot say definitively about the timing of reducing the ETF balance sheet (QT)

·         We've confirmed a virtuous cycle of wages and prices

·         The policy framework of QQE with yield curve control and negative rates fulfilled their roles

·         Accommodative financial conditions will be maintained for the time being

·         We will continue buying broadly the same amount of JGB buying as before

·         We will use the short-term policy rate as our main tool

·         A judged, sustainable, and stable achievement of a 2% inflation target comes in sight

·         Recent data shows a virtuous economic cycle strengthening

·         The price target is now in sight

·         Accommodative conditions will firmly underpin the economy and prices

·         We don't expect deposit rates and lending rates to spike following today's decision

·         We will consider options for easing broadly including ones used in the past if needed

·         Our accommodative stance is to support the economy and prices

·         We will set short-term interest rates just like other central banks that use short-term rates as a policy tool

·         There is still a distance to the 2% target when looking at inflation expectations

·         We are to decide the appropriate rate level depending on the economy

·         QQE policy framework of negative rates, YCC has fulfilled its role

·         It's important to keep an easy environment in place considering the distance to the 2% target in terms of inflation expectations

·         The pace of further rate hikes depends on the economy and price outlooks

·         We will consider reducing JGB buying at some point in the future

·         We are seeing positive signs in Japan's economy

·         Markets will decide long-term yields

·         The likelihood of achieving a 2% inflation target is still not 100% but it's rising

·         We expect further rises in price trends to lead to rate hikes

·         The BoJ's massive holdings of JGBs have an impact on easy monetary conditions

·         But we will not use JGB buying operations and balance adjustment as proactive monetary policy tools (YCC)

·         The outcome of spring wage negotiations was a big factor

·         If the price outlook overshoots or shows the possibility of overshooting, that could lead to a change in monetary policy

·         The pace of further rate hikes depends on the economy, price outlooks

·         We will carry out 'regular' monetary policy

·         'Easy monetary environment' is defined as the actual interest rate being lower than the neutral rate of interest

·         We are not thinking of telling the definitive upper yield cap to the market operations division

·         I don't think we will set an upper limit in bond yields when determining the appropriate level for conducting market operations

·         We are closely watching whether the trend of big wage hikes could broaden among small firms

·         No comment on short-term currency moves

·         We are to a mull policy response if FX makes a big impact on the outlook

·         We will consider a monetary policy response if currencies cause a big impact on the economy and prices

·         We are at a phase where we can slowly proceed with possible rate hikes

·         If the price outlook overshoots or shows the possibility of overshooting, that could lead to a change in monetary policy

Post BOJ policy reaction:

·         Japan's PM Kishida: We're not thinking about reviewing the government and BoJ joint statement.

·         Japan's PM Kishida: To declare the end of deflation, we need to make a comprehensive judgment.

·         Japan's Finance Minister Suzuki: We are closely monitoring the economy and financial markets including Forex after the BoJ decision.

·         BoJ's Suzuki: The BoJ's monetary policy change doesn't necessarily mean the end of deflation

·         Japan's Finance Minister Suzuki: We will assess comprehensively based on various indicators before announcing the end of deflation

·         Japan's Chief Cabinet Secretary: We expect the BoJ to conduct the monetary policy appropriately to achieve the 2% price target sustainably and stably.

Conclusion:

Overall, there is a huge policy divergence between the Fed and BOJ. If we adjust the average core inflation, the real U.S. /Fed repo rate is now around +1.50% against BOJ/Japan’s -3.60%. Also, BOJ is still running QE, while Fed is on QT. This is causing huge JPY depreciation against USD and even EUR, and GBP, causing a vitreous cycle of higher imported inflation and stagflation despite the advantage in exports. Also, geopolitical tensions with Russia and China are causing significant supply chain disruptions in Japan, causing more imbalances between demand and constrained supply.

As per Taylor’s rule, for Japan:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(4.00-2.00) =0+2+2=4.00%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation=4.00% (2023 average)

As per Taylor’s rule, Japan’s repo rate should be around 4.00% instead of the present +0.30%. Even if we assume a potential output growth gap of around -1%, Japan’s repo rate should be around +3.00% in the long run (by 2025-26).

Normally, a Central Bank should do its job to bring down inflation/ensure price stability by hiking rates into the restrictive zone (real positive rate) so that the resultant higher borrowing costs curtail demand/consumer spending, corporate and even government spending, allowing constrained supply side of the economy matches, and ultimately inflation normalizes/falls. This is exactly what is being done by the Fed, ECB, BOE, and almost all other G20 central banks, where core inflation is still running hot.

But despite that BOJ/Japan Government is not ready to hike or even normalize/exit the current ultra-easy monetary policy as Japan is the only among few major economies in G10, which is paying around 12-15% of its tax revenue as interest on a huge public debt against U.S. 15% and EU/China’s 5.5%, far ahead of the AEs, which is a red flag and thus despite various narratives, BOJ is not in a position to normalize policy rate even after core inflation now hovering above +4.0%, substantially higher than the target.

Japan/BOJ has no option but to keep the bond yield/coupon rate at an artificially ultra-low level to keep borrowing costs minimal, so that it does not go above the 15% of the revenue red line. Japan/BOJ improved the borrowing cost ratio to 11.67% in FY22 from 13.50% in FY21 (relative to total revenue). BOJ now holds almost 50% of the total JP public debt.

But decades of artificially lower bond yield environment are also weakening Japan’s bank & financials, wage growths, and overall consumer spending. Japan is now entering a deflationary to a stagflationary cycle. If core inflation continues to surge and becomes sticky/elevated around 5%, then BOJ’s ultra-easy monetary policy may cause more devaluation for the currency/Yen and cause more imported inflation, everything being equal (despite BOJ/Japanese government jawboning that they are ‘watching’ Yen movement).

BOJ just normalized its symbolic special reverse repo rate of -0.10% to +0.10% without and repo rate hike and quitting JGB buying (QE). Looking ahead, BOJ may start hiking the repo rate, presently at +0.30% in H2CY24 by +75 bps to match possible Fed action when the Fed starts to cut, which will cause lower policy differential, lower USDJPY, lower imported inflation, higher JGB bond yields, higher NIM/NII for banks & financials and higher wage growths and an end of the vicious cycle of deflation (?).

Market impact:

BOJ policy impact: The dovish hike and the normalization of selective negative reverse repo rate were already well anticipated.

Although, BOJ is famous for its negative interest rate policy (NIRP), in reality, the effective reverse repo rate was already around 0% or +0.10%, while the repo rate is +0.30% and no banks ever make the ‘complementary deposit’ above a certain limit in a special current account with BOJ, so that it has to pay an interest of +0.10% to BOJ under reverse repo rather than the usual opposite.

BOJ’s repo rate is still now +0.30% (unchanged since Dec’2008) against the Fed’s current rate of +5.50% and ECB’s +4.75% despite comparable core CPI; 6M average of around +4.30%, resulting in a deep negative real repo rate around -4.00% against Fed’s +1.20%. The bank lending rate (BLR) of Japan is now around +1.48% against the US +8.50% and China +3.45%.

BOJ was trying to keep the 10YJGB bond yield at minimum levels, now below +1.0% by sheer jawboning and a false perception of a negative interest rate; in reality, BOJ’s repo rate was +0.30% against Fed’s +5.50%, while the effective reverse repo rate +0.10% against Fed’s +5.40%. In this way, due to the very low repo rate, reverse repo rate, and bank lending rate, banks & financials have very low NIM compared to their US peers, leading to subdued wage growth and the vicious cycle of deflation. BOJ officially maintains a negative reverse repo rate (tiered), so that banks are discouraged from parking their excess funds at BOJ and encouraged to lend to the real economy (forced lending policy is the World’s financier, especially in US bonds, startups, and infra projects).

On Wednesday/Thursday, USDJPY tumbled on a dovish hike by BOJ as it did not indicate any repo rate hike and continued the QE. The yen plummeted despite the BOJ ending the world's final negative interest-rate policy (NIRP) as the BOJ emphasized that financial conditions would remain favorable. Moreover, BOJ Governor Ueda adopted a dovish tone during the presser, stating there is still a risk the inflation target may not be met. While the BOJ formally discontinued its YCC, it committed to continue purchasing long-term government debt; i.e. just shifted from QQE to QE.

But late Thursday, USDJPY stumbled from around 151.82 after the Fed’s dovish hold (as the Fed indicated QT tapering and close of QT shortly). The market is now expecting -100 bps rate cuts each in 2024 and 2025. Wall Street Futures and Gold jumped to a fresh life time high, although Fed SEP/dot-plots show -75 bps rate cuts both in 2024 (H2) and 2025. The market may have interpreted wrong about Powell’s comments about elevated core inflation in January and February as seasonal noise; the market is now again expecting 4 rate cuts by the Fed in 2024 from June, although the Fed may stick to 3 rate cuts from July.

Looking ahead, whatever may be the narrative, technically, USDJPY (151.00) now has to sustain over 152.00-153.00 for a further rally; otherwise, sustaining below 151.50 may again fall to 149.00-147.00 in the coming days.