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Japan Formally Ended Its YCC Policy And Had Its First Rate Hike In 17 Years: What This Mean For Everyone?
AInvestTuesday, Mar 19, 2024 4:26 am ET
5min read
BLK --

The Yield Curve Control (YCC) was finally ended by BOJ, but many analysts already started speculating about the potential market effect of this huge monetary decision.

On March 19th, the BOJ voted 7:2 to end negative interest rates, raise the base interest rate from -0.1% to 0~0.1%, and formally cancel the YCC policy. At the same time, the central bank also announced the discontinuation of the purchase of ETFs and Real Estate Investment Trusts (REITs) but will continue to purchase Japanese government bonds at the previous scale.

After the decision was announced, the U.S. dollar against the yen continued to rise, approaching the 150 mark. Ten-year Japanese government bond yields rose slightly to 0.762%, from around 0.75% beforehand. The yield on the most interest rate-sensitive 2-year Japanese government bonds edged lower to 0.177%, from around 0.18%.

Meanwhile, the Nikkei 225 index and the Topix index turned higher after a short-term decline.

The process of normalization of monetary policy would still be gradual

Although exiting negative interest rates and YCC, market participants broadly expect Japan's exit from quantitative easing policy to still be gradual. The Bank of Japan also said today that it will temporarily maintain a loose monetary environment, and the Bank of Japan will implement monetary policy according to circumstances.

Gregor Hirt, Global Multi-Asset Investment Director at Allianz Investment suggests that expectations should not be too high for the Bank of Japan's exit from unconventional monetary policies, since Japan's economic situation has recently shown some vulnerability.

Hirt points out that the revised economic growth data barely avoids a technical recession, but the continued decline in real income of Japanese households has kept domestic consumption weak. Against this backdrop, any policy adjustments will be gradual.

In addition, the BOJ has also repeatedly emphasized that its goal is gradual transition rather than sudden interruption of policy. Therefore, he expects that the central bank will not directly start a tightening cycle at the moment, and any further interest rate hikes will be highly data-dependent, and come with uncertainty.

Brian Coulton, Chief Economist at Fitch Ratings, also suggests that the virtuous cycle between wages and prices, long desired by the BOJ, has actually emerged, as this year's labor-management negotiations have resulted in another substantial wage increase and are consolidating this trend.

Moreover, while Japan's overall inflation has fallen from last year's peak, service sector inflation, which better reflects domestic price pressures, has remained slightly above 2% for about six months. Companies are also more confident in passing on increased labor costs to customers, and worker and employer inflation expectations remain high. Given the above economic environment, Fitch expects a gradual process of normalization of The BOJ's monetary policy.

Aaron Rock, Head of Nominal Rates at Amundi, a European asset management giant, believes that after the first interest rate hike, The Bank of Japan will continue to emphasize that policy will remain easy, and may wait until the third quarter for another hike, pushing policy interest rates up to 0.25%.

Morgan Stanley emphasized, that despite the abolition of negative interest rates and YCC, the Bank of Japan will not taper. The investment bank thinks the abandonment of YCC does not deny the ability of the BOJ to buy long-term Japanese government bonds to counter sudden increases in long-term interest rates, and the YCC framework is also important for other assets (such as ETFs and J-REITS) on its balance sheet.

How will it affect Japanese stocks, bonds, and foreign exchange?

Before this meeting, going short on Japanese bonds and long on the yen were choices of many institutions. Many analysts predict that considering Japan's exit from the quantitative easing policy is gradual, the next steps will continue to be bearish on Japanese bonds, and bullish on the yen and Japanese stocks.

Hirt thinks that the market has largely digested the possibility of a preliminary policy adjustment, which has limited the impact of actual policy adjustments on the market.

Therefore, he continues to be cautious about Japanese government bonds and moderately optimistic about the yen. Although the Japanese stock market may be affected in the short term by the strength of the yen and recent capital flows, moderation of the BOJ's tightening policy, coupled with attractive corporate valuations and profit prospects, should continue to be beneficial to the Japanese stock market in the medium term.

Ahead of this interest rate decision, BlueBay Asset Management, under the Royal Bank of Canada, made shorting 10-year Japanese government bonds its biggest macro bet. The institution expects the yield on 10-year Japanese government bonds to rise further to above 1.25% by the end of this year.

Jessica Hinds, an economist at Fitch Ratings, also believes that Japanese bond yields will rise, but thinks the rise will be limited. She analyzed that although the market had indeed priced in the end of the Bank of Japan's negative interest rates and YCC, yields on Japanese government bonds have not risen much.

For example, the yield on 10-year Japanese government bonds has increased but is still far below the peak of October 2023, which is slightly less than 1%. Given that the 10-year OIS rate is approximately 0.92% at present, Japanese government bonds could continue to face upward pressure. However, other major central banks have already signaled that rates have peaked and may be cut later this year, which could limit the rise in Japanese government bond yields.

Blackrock and the British hedge fund Man PLC believe that with the recovery of economic vitality, there is further room for Japanese stocks to rise. Yue Bamba, head of active investment in Japan at BlackRock, suggests this policy change is a major event, but the rate-hiking process is expected to be gradual, maintaining a loose monetary environment and supporting the stock market. The drivers of Japanese stock growth are also diverse, broad, and durable. Therefore, there is a long way to go before we fully price Japanese stocks.

Nomura Fund also suggested investors view positively the impact of the normalization of Japan's monetary policy on the Japanese stock market. Exiting negative interest rates does not mean that the yen can appreciate significantly over the long term. As long as the yen exchange rate tends to stabilize, it would eliminate short-term disturbances to the Japanese stock market, and Japanese stocks will still resume their upward trend.

Therefore, exiting negative interest rates or experiencing short-term volatility or pullback in Japanese stocks just provides investors with a good opportunity to go long.

How The Global Market Will Be Impacted?

Japanese investors hold as much as $4.43 trillion in foreign securities. Therefore, Japan's two adjustments to its YCC policy last year each briefly impacted global markets, particularly the global bond market. However, Market insiders broadly believe it will create a short-term shock, but overall, the impact will be limited.

According to a survey last week of 273 industry insiders, only about 40% of respondents said that the Bank of Japan's first rate hike since 2007 would spur Japanese investors to sell their foreign assets and repatriate the proceeds. They believe that after a limited increase in the BOJ's policy interest rate, Japan still maintains a significant interest rate gap with other major economies, insufficient to prompt Japanese investors to change their stance.

Brown also told reporters that the market has already priced in the Bank of Japan's policy, and given that the Bank of Japan is not going to be aggressive but will gradually exit its negative interest rate policy and YCC policy, the Bank of Japan's decision this time is unlikely to shock the market as it did last year.

Data also show that, despite rising expectations of a shift in the Bank of Japan's policy, Japanese investors in the first two months of this year still bought ¥35 trillion in foreign bonds. Last year, they had purchased ¥189 trillion in foreign bonds, the largest amount in three years.

Hideo Shimomura, a senior portfolio manager at Fivestar Asset Management, said, We're seeing large retail outflows into foreign bonds and equities and I don't think the end of the BOJ's sub-zero rate policy will change this trend.

Yet, Heinz does think Japan's raising rates could likely put upward pressure on bond yield rates in other developed markets. After all, Japan is an important investor in foreign assets, and higher domestic yields for Japanese investors will somewhat reduce their demand for foreign assets and could lead to the sale of existing assets.

Disclaimer: the above is a summary showing certain market information. AInvest is not responsible for any data errors, omissions or other information that may be displayed incorrectly as the data is derived from a third party source. Communications displaying market prices, data and other information available in this post are meant for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of any security. Please do your own research when investing. All investments involve risk and the past performance of a security, or financial product does not guarantee future results or returns. Keep in mind that while diversification may help spread risk, it does not assure a profit, or protect against loss in a down market.