BOJ Speculation Moves to Negative Rate Policy From Yield Cap

Investors keeping an eye on Bank of Japan policy have shifted their attention to the possible end of the central bank’s negative interest rate following the loosening of guide rails around bond yields.

(Bloomberg) — Investors keeping an eye on Bank of Japan policy have shifted their attention to the possible end of the central bank’s negative interest rate following the loosening of guide rails around bond yields.

While no changes are expected at this week’s policy meeting, swap market indicators now show stronger expectations for the near-term scrapping of the subzero rate by March than a further widening of the band around the BOJ’s 10-year yield target.

The central bank’s more flexible control of yields since the end of July and comments by Governor Kazuo Ueda on the possibility of raising the short-term rate are among the factors fueling the latest speculation. 

Ending the world’s last negative policy rate would mark a major shift away from the central bank’s large-scale stimulus after more than a decade of easy money. It’s a move that could strengthen the yen, push down stocks outside the banking sector and prompt a change in capital flows to and from Japan.

The yen slid past 148 versus the dollar Wednesday to its weakest level this year, underscoring pressure on the central bank. US Treasury Secretary Janet Yellen and Japan’s top currency official Masato Kanda have been keeping in close contact over moves in the currency, with Kanda describing excessive moves as unwelcome. 

Since July when the BOJ said it would allow yields on 10-year government debt to rise toward 1%, option-implied volatility in two-year yen overnight-indexed swaps has risen compared with the corresponding gauge for 10-year contracts. Previously, the bank had drawn a line in the sand at 0.5%. The benchmark 10-year yield rose to as high as 0.725% Wednesday, a level last seen in 2014.

The new BOJ policy cap is still about 30 basis points above yields in the secondary market, so a further increase in the ceiling looks less likely than raising the minus 0.1% interest rate.

“The 10-year yield control has become a dead letter,” said Kiyoshi Ishigane, chief fund manager at Mitsubishi UFJ Kokusai Asset Management Co. in Tokyo. “Short-term yields will rise more than longer-dated yields as the market prices in an exit from negative rates.”

That pricing has moved forward by six months since the last policy decision in July. 

While the July tweak helped trigger the switch in focus to the negative rate, Ueda’s recent interview with the Yomiuri newspaper offered extra fuel for the change in perceptions. 

He said it was not out of the question to have sufficient data by the end of the year to discern if wage gains were sustainable. Raising rates was among the options for the bank if prices and the economy proved stronger than expected, Ueda added. The story pushed up yields and briefly helped strengthen the yen.

BOJ officials viewed the comments as offering no new signal on policy, people familiar with the matter told Bloomberg News last week. The governor will have the first chance to clarify the comments at a press conference Friday following the policy decision.

Regardless of the intentions behind the comments, demand for one-week yen call options is near the highest in about eight weeks relative to puts, according to so-called risk-reversal rates, suggesting options traders are hedging against a jump in Japan’s currency. The yen has weakened almost 6% since July 27 when the central bank started the two-day policy meeting.

“There appear to be option traders hoping that the BOJ will adjust policy and that investors will unwind short positions,” said Kenta Tadaide, chief FX strategist at Daiwa Securities Co. in Tokyo. “While an increase of 10 or 20 basis points is a big move for yen rates, it isn’t for the dollar, so the impact from any BOJ policy tweak on the yen would likely be limited.”

Despite the jump in speculation of a rise in interest rates down the line, some investors still see the yen staying weak for now. 

Asset managers such as pension funds and insurers as well as hedge funds are holding on to bearish bets on Japan’s currency amid wide yield differentials between Japan and economies overseas.

–With assistance from Toru Fujioka.

(Adds in 5th paragraph that yen passed 148 versus the dollar to weakest point in 2023.)

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