The world's three most important central banks are about to announce their monetary policy updates. The Bank of England is likely to cut borrowing costs on Thursday, while the Federal Reserve is likely to keep interest rates unchanged on Wednesday but hint at a possible cut in September. But the most important decision may come from the Bank of Japan.
Because the recent volatility in the U.S. stock market, especially the massive sell-off of large technology stocks, coincided with the strengthening of the yen, it attracted investors' attention. A theory quickly formed: if the Bank of Japan is about to raise interest rates, and the Federal Reserve is about to cut interest rates due to recent weak inflation data, this will narrow the interest rate gap between the United States and Japan, making the yen more attractive. Therefore, investors who borrowed yen to buy large U.S. technology stocks have to quickly reduce these positions to respond to the strengthening of the yen.
This may be true, but there is no data or reliable evidence to prove it. Perhaps the connection between the stronger yen and the decline of large US technology stocks is just coincidental. Or the causality may be reversed, that is, the yen, although it recently fell to a 38-year low, still maintains some safe-haven value and attracts buyers when US stocks fall.
Regardless, the correlation between the two is real, which means the BoJ rate decision could be the first strong driver of markets this week amid uncertainty over how much the central bank will tighten policy.
Charu Chanana, head of FX strategy at Saxo Bank, noted that the good news for those worried that the Bank of Japan will spark volatility in broader markets is that the bank "has a long history of disappointing hawks."
Indeed, the Bank of Japan is likely to tighten monetary policy by reducing its bond purchases. Chanana expects the Bank of Japan to announce a reduction in its monthly purchases of five- to 10-year bonds from 6 trillion yen (about $32 billion) to 5 trillion yen (about $27 billion), and further to 3 trillion yen (about $19.5 billion) within two years.
Chanana pointed out, however, that traders are not so sure whether the Bank of Japan will raise its main interest rate from the current 0.1%. The market has only priced in about a 50% probability of a 15 basis point rate hike, which actually means that the market is betting that the Bank of Japan will raise interest rates by 7-8 basis points.
She believes it is unlikely that the Bank of Japan will simultaneously raise rates and significantly reduce its bond purchases. "Two hawkish actions in one monetary policy meeting may be a bit too much for a central bank that is inherently dovish," Chanana said.
Therefore, the meeting may not have as much impact on the market as some people expect. Chanana believes that with the rapid appreciation of the yen last week, many policy changes may have been digested by the market.
"Unless U.S. recession risks increase significantly or the Fed turns more dovish, continued appreciation of the yen and a fall below 150 yen to the dollar are unlikely," Chanana said.
If the Bank of Japan falls short of more hawkish expectations and signals caution, “the yen-funded carry trade could become popular again,” Chanana added.
That's good news for Japan's Nikkei 225 index, which typically moves inversely to the yen. And the still-cheap supply of money in Japan is likely to support sentiment in global equities, too.
The article is forwarded from: Jinshi Data
