Technical Analysis

The hyenas are circling the Bank of Japan

The pressure continues to ramp up ahead of Wednesday’s Bank of Japan decision as sellers flood the Japanese bond market.

Last Thursday/Friday, the BOJ spent the equivalent of $72 billion (¥5 trillion on Friday alone) to defend the 0.50% ceiling on 10-year Japanese notes. Even with that, the 0.50% ceiling broke and it briefly broke again today, touching 0.52% despite another ¥1.2 trillion.

The status quo isn’t going to last and there are multiple reports saying the BOJ will increase its 2024 inflation forecast to its 2% target, setting the stage for normalization.

So the big question is how we get there and it’s a daunting task that will mostly be left to Kuroda’s successor (his term ends in April).

The problem is that the BOJ is trying to end the largest experimental monetary policy experiment in history. They boosted the ceiling to 0.50% from 0.25% in December but repeatedly said that was a technical move. It also highlights the problems in withdrawing an unlimited QE policy with only a yield cap.

It’s a green light for the market to dump bonds on the central bank and a one-way trade. Another incremental 25 bps hike in the limit would only encourage more of the same. It’s another crack in the dam.

The problem is that the BOJ is a wounded animal and the hyenas are circling.

They have a whole menu of options, I’d argue that 25-50 bps of a hike in yield limit is priced in already, so there’s scope for disappointment (as Justin wrote). But the BOJ could also pivot to a value QE system, with monthly limits similar to what the Fed and other central banks did for years. With that they could lay out a path to ending QE. Or they could abandon QE altogether.

What has the market feeling a bit more comfortable today and the yen softer (i.e. USD/JPY higher) is a comment today from Hiroshige Seko, the Liberal Democratic Party’s upper house secretary general, who said “now is not the time for making a major policy change.”

I believe that much of the Treasury buying we saw late last week was because of Japanese bond machinations and that the market misinterpreted it as a dovish shift in global sentiment. That adds to risks on Wednesday.

In any case, my message is that traders of all stripes need to be cognizant of the BOJ risks because whatever they do, it will reverberate.

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