Technical Analysis

The yen is screaming about the risks around the Bank of Japan


I’m shocked at the lack of commentary around next week’s Bank of Japan meeting and how that’s reverberating through markets.

The Bank of Japan decision is Wednesday (late Tuesday US time) and the FX market is screaming that risks around it are rising.

There have been persistent reports of the BOJ boosting its inflation forecasts at the meeting and yesterday Yomiuri reported that the BOJ will review the side effects of its easing at the meeting. Since then, USD/JPY is down nearly 400 pips and has fallen to the lowest since May.

USDJPY daily

I also believe that the risk of Japanese investors getting rugged in Japanese bonds is what’s putting the bid into Treasuries. That’s sent a false dovish signal to equities and is reverberating elsewhere.

So what happens if the BOJ shifts policy?

In December the BOJ surprised the market by moving the yield curve control limit on 10s to 0.50% from 0.25%. That led to a 600-pip one-day drop in USD/JPY even though the BOJ insisted it was only a technical change.

The market is certainly sensing change here but there’s no sense of what it will be. Just another 25 bps in YCC might lead to a relief rally in USD/JPY at this point but you can’t rule out the BOJ dropping it altogether. Moreover, a forecast for a return to the inflation target in 2024 also sets the stage for a normalization of policy, which in BOJ terms is probably a 1.00% policy rate.

But given heavy BOJ intervention in the bond market, the path to free trading in JGBs once again is an extremely perilous one that could create enormous paper losses. I could script a scenario where that could be either bullish or bearish for US Treasuries because there could be a safe haven bid (like there is now) or funds blowing up.

In general though, volatility is bad news and that will hurt equities and weigh on global growth sentiment.

For now, my playbook is to pare exposure and keep a very close eye on Japan.

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