The yen sinking to even deeper lows. Short sellers driving Japanese bond yields through the central bank’s target. Stocks on a rollercoaster ride and credit investors running for the sidelines.
These are some of the scenarios investors envisage as Haruhiko Kuroda doggedly clings to ultra-low interest rates in his final nine months as Bank of Japan (BoJ) governor. His clash with markets looks set to intensify as runaway inflation forces global rates higher while he tries to resist long enough to entrench price gains in Japan.
“It all comes down to the BoJ’s policy and the weakness of the yen,” said Amir Anvarzadeh, a strategist at Asymmetric Advisors Pte, who has tracked Japanese markets closely for three decades. “How the BoJ navigates monetary policy and inflation will impact everything from stocks to credit and provide opportunities to short JGBs - it will keep happening until their view on rates changes.”
In the meantime, Wall Street is lining up its bets.
Brown Brothers Harriman & Co tips the yen to slump past 140 versus the dollar - a view shared by hedge funds and one that implies the BoJ will let Japan’s yield gap with the world widen.
Yet the weaker currency may ultimately force Kuroda to relent. JPMorgan Asset Management is selling government bonds on a wager he’ll loosen his grip, letting benchmark yields rise in Japan like elsewhere.
SMBC Nikko Securities Inc projects more losses for equities before a recovery toward the end of the year, while credit funds are wary of investing at all until volatility subsides.
Selling the yen remains one of the hottest macro trades after Kuroda rammed home the message at the last policy meeting in June that it’s too early to cut back on stimulus.
The worst-performing Group-of-10 currency this year fell to 137 per dollar last week, the lowest since 1998. Credit Suisse Group AG strategists forecast a drop to 138 over the next three months while JPMorgan Chase & Co envisage a test of 140.
“With BoJ dovishness being maintained, we still believe the pair will eventually test the August 1998 high near 147.65,” Win Thin, New York-based global head of currency strategy at Brown Brothers, wrote in a note.
Still, the yen’s swings are closely tied to Treasuries and demand for the dollar. A peak in US rate-hike expectations in the coming months may soothe some nerves and fears of a recession could spur a rally in haven assets including the yen. “If you believe the Fed will be successful on inflation, then the dollar peak could come as we expect around the turn of the year,” said National Australia Bank Ltd.’s Rodrigo Catril. That’s “a dynamic that should see dollar-yen trading sub 130 by the end of the second half of 2022.”
The yen halted a two-day rally in Tokyo yesterday, trading around 135.50 versus the dollar in Tokyo.
Traders may also boost bearish bets on Japan’s $9tn bond market.
Graticule Asset Management Asia Pte, Schroders Plc and BlueBay Asset Management are among funds selling JGBs. Ten-year yen interest-rate swaps have crossed the central bank’s 0.25% line in the sand, signalling investors expect policy makers will be forced to capitulate.
“We are negative on JGBs,” said Arjun Vij, a money manager at JPMorgan Asset, who is shorting the bonds. Investors “will continue to test the BoJ’s commitment to the yield-curve control, but ultimately, the BoJ will only shift its stance when the economic and political environment is right.” Should the yen breach the 150 level and lift Japan’s core price growth further, it may “fulfil the necessary conditions for sustained inflation and cause the BoJ to respond,” Morgan Stanley strategists including Chetan Ahya wrote in a note. The BoJ would “move quickly to shift its forward guidance, adjust its YCC yield target, and hike policy rates by 15 basis points in a subsequent meeting.”
But getting the timing right could be tricky. While inflation data for Tokyo released on Friday showed headline price gains of 2.3% in June, the increase was less than half this after stripping out volatile inputs for fresh food and energy.
The underlying price trend remains too weak to make recent core inflation moves above 2% sustainable and to force a shift from Kuroda, Kazuo Momma, a former top official in charge of monetary policy at the central bank, said yesterday on Bloomberg TV.
The BoJ has essentially told the market that it won’t be bullied into tightening policy and will do so on its own terms, said Prashant Newnaha, strategist at TD Securities in Singapore. “That said, if the yen weakens against a backdrop of rising foreign bond yields, we would expect the market to reload on shorts and retest the BoJ.”
While macro funds rush to trade, credit investors are cautious, with Japanese corporate debt sales falling in June. Investors saw some of the worst returns on yen debt since March 2020.
Uncertainty over BoJ policy will only intensify toward year-end and this may curb corporate bond sales, said Kazuma Ogino, a senior credit analyst at Nomura Holdings Inc.
“Investors may stay on the sidelines for another three months or so until volatility in interest rates eases,” said Tsuyoshi Yoshikawa, a senior credit analyst at SMBC Nikko. “We see that July’s pipeline is recovering, but still, the details regarding the amount of notes that these companies are planning to issue are up in the air.”
Stock pickers are also bracing for turbulence.
Local equities could be hammered by waning appetite for risk assets as Federal Reserve rate rises raise concern of a recession. The good news is that a falling yen should bolster export earnings, which could help ailing sentiment.
Haruhiko Kuroda, governor of the Bank of Japan.
