(4-minute read)  | 

All eyes were on the Bank of Japan (BOJ) this morning in what seems to be the most anticipated central bank meeting of the year so far. Volatility was getting compressed ahead of the meeting as markets awaited a pivotal decision on the account of rumours that the BOJ will change its previously-thought fixed monetary policy stance.

This came a month after the BOJ made changes to its Yield Curve Control (YCC) policy, changing the band of the JGB 10-year yields from a range of 25 basis points (0.25%) above or below, the 0% to a range of 50 basis points (0.5%) above or below the 0% range.

The move has signalled to markets that the BOJ is warming up to slowly changing its monetary policy stance, which still came as a shock to markets as they were previously hard bent on keeping it unchanged.

In the days leading up to the meeting, the JGB 10-year yields were breaking above the 0.5% threshold which prompted crazy levels of money printing and blowing through reserve assets to finance the suppression of yields (buying government bonds) below the top of the stated range. Because of the BOJ’s struggle to keep yields low, market speculators were betting on a change in monetary policy to let yields go higher to protect the BOJ’s reserves.

Much to the dismay of speculators, the BOJ kept policy unchanged even though they announced last week that they would be reviewing effects of their massive easing policy. Yields immediately retraced, managing to reach 0.36% before going slightly back up again.

The narrative on yields is an important driver to watch for the Yen and the Japanese stock indexes (Japan being an export economy and is reliant on a weaker Yen) as current low interest rates will prompt borrowers to borrow in Yen and convert it to another currency for spending, driving down the value of the Yen.

However, as the momentum in rate differentials top out (other central banks are expected to slow or pause hiking), flows are benefitting the Yen again after a disastrous performance in 2022. Speculators have started to take profits on Yen shorts in anticipation of a change in Japanese monetary policy and a Fed pivot.

The current status quo of burning through reserves and printing money to finance the purchasing of government bonds will slowly build up geopolitical risk between Japan and the US. Japan holds over USD $1 trillion in US Treasuries as reserve assets, making it the largest foreign holder of US Treasuries. As China has seen from the effects of Russia’s invasion of Ukraine, holding reserves in western assets will be considered digging your own grave as Russian foreign Treasury holdings were frozen in western bank accounts following the invasion.

The Chinese and the Japanese are the two largest foreign holders of Treasuries by a large margin, and should they start selling Treasuries in bulk (China is currently converting its US Treasuries to Gold), US pension funds will see their portfolio valuations collapse. This will morph into a political issue in the US as American citizens see the value of their retirement holdings dwindle day by day.

From what is seemingly a domestic issue, the BOJ’s actions will be a huge tail risk to the currency and interest rate markets (which will spill over to the US stock market). We will be watching this space very closely for the year ahead.