Most economists had not expected this move until next year. Bank of Japan Governor Haruhiko Kuroda argued that the shift should not be viewed as a tightening of monetary policy, saying “this measure is not a rate hike” and did not signal the end of Japan’s efforts to prevent yields from rising.
Despite these assurances, markets appeared to interpret the development as a sign that Japan was struggling to maintain its ultra-easy monetary policy as other central banks have been hiking rates. After hawkish policy statements last week from the European Central Bank, the move was taken as an indication that no central bank could be relied on to remain dovish. Following the move, the yield on Japan’s 10-year government bond rose 15 basis points to 0.41%, the yen initially rose 2.8% against the US dollar to 133.2, and the Nikkei fell 2.5%. The decision had broader global implications, with concerns that global tightening has further to go, pushing up the yield on the 10-year US Treasury by 8bps to 3.66%. S&P 500 futures were initially down over 1%, though later pared this loss to be flat ahead of the start of US trading.
It remains to be seen whether Japan’s surprise move is the start of a broader tightening. But pending further guidance, we see the following implications:
Tightening outside the US adds to downward pressure on the US dollar. We had been expecting the yen to appreciate modestly against the US currency through next year, with USDJPY going from 133 at present to around 125 by the end of 2023. The question for markets now will be whether the Bank of Japan will allow yields to rise further when the new governor takes over from Kuroda in April. This could put additional upward pressure on the yen. Overall, we believe that the US dollar will weaken in 2023, given that the US Federal Reserve is closer to an end of its tightening cycle that other major central banks.
Upward pressure on Japanese yields could also increase, depending on the evolution of monetary policy. In the near term, we expect the yield on the 10-year Japanese government bond to fluctuate between 0.4% and 0.5%. The BoJ framed the latest move as an attempt to improve the functioning of the JGB market, since increasing official purchases of bonds have undermined liquidity. As a result of efforts to curb yields, the BoJ now owns more than half of outstanding government bonds, up from 11.5% when Kuroda became governor in 2013. As with the currency, the outlook will depend on whether policy shifts further under the next governor, who could allow a further rise in yields or even scrap the yield control policy altogether. This possibility creates upside risks for yields.
The outlook for Japanese stocks looks muted. The modest appreciation in the yen that we expect in 2023 would be negative for Japan’s export-oriented equity market. However, we also expect corporate earnings to rise 3% for fiscal year 2023, as a full reopening following COVID increases mobility and consumption. We also expect a lift from more Chinese tourists traveling in Japan due to the relaxation of pandemic restrictions in China. While we are neutral on Japanese equities, we do see the Topix ending the year higher. The move higher in yields also boosted Japanese bank stocks, a sector we favor in the country, with the sector rising around 5%on hopes that Japan is moving away from an ultra-easy monetary policy, which is harmful to bank earnings. Globally, we expect an inflection point for markets in 2023, with an end to monetary tightening and a revival in growth boosting sentiment.
So, the BoJ’s move leaves many questions unanswered. It remains to be seen how policy will develop under the next governor. However, the unexpected change to the yield cap suggests that it is becoming harder to maintain dovish monetary policy while other top central banks are tightening aggressively. This adds to our view that the US dollar will come under further pressure in 2023.
Main contributors - Mark Haefele, Daiju Aoki, Christopher Swann, Vincent Heaney, Thomas Flury, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Bank of Japan surprise adds to global tightening fears, 20 December 2022.