Could The Bank Of Japan Move Earlier Than Expected?
Commentary
Written by Richard Lee, Currency Analyst
Given the recent string of central bank surprises in the past month or so, one has to wonder whether or not the currency markets may be in for a doozey when Bank of Japan officials meet this week. Although the market is overwhelmingly confident that rates will not change this time around, there is a small contingent that believes either a rate hike or considerably more hawkish comments could ultimately emerge. And there’s plenty of economic data to back up this speculation.
Some will remember to the beginning of the year when the Canadian dollar was discarded as a nonstarter currency. However, with economic growth in full force recently, the underlying currency has been on a 1000 basis point tear against the US dollar over the past several months. The same can be said of the world’s second largest economy. With things just beginning to change slightly in Japan, conditions may be prime for a breakout.
What’s Changed In Japan?
Since the beginning of the year, economic fundamentals have improved significantly. First and foremost, inflationary pressures have remained positive for consecutive months. Although still hovering near the zero percent level, current price increases are far from the deflationary levels that were clearly evident the previous year. Unfortunately, this has been spurred on by rising producer prices and corporations passing the higher cost onto the market, rather than the legitimacy of higher prices on demand. Domestic consumption continues to remain weak in the economy, helping to keep increases at bay. The notion lends to speculation that should consumers pick up spending habits, the figure will very well increase, grabbing the attention of the Bank of Japan. However, as policy makers have noted, consumer inflation is not the sole reason to lift rates. And so we turn to growth. Recently, gross domestic product, a measure of expansion in the economy, outpaced both the Eurozone and the United States. Posting a second consecutive quarter of expansion, annualized growth hit 3.3 percent in the second quarter of the year. The figure, founded on a strong export sector, is eventually going to lead to higher rates of inflation as productivity and employment emerge. Bank of Japan Governor Toshihiko Fukui is confirming the bullish bias, forecasting that economic growth is to remain above trend, expanding at 2 percent well into 2008. Ultimately, the notion is likely to serve as the impetus for officials to increase rates ahead of schedule even if pressure comes in the form of governmental bantering.
Political Pressure – In All Forms
An earlier move would also help divert any potentially rising focus on the undervaluation of the Japanese yen, keeping the world fixated on the Chinese yuan. Traders will hark back to the era of 2003-2004 when the Japanese yen was the focus of G8 meetings as global trade partners worried about the competitiveness of Japanese made goods. This purported considerable intervention by the Bank of Japan in order to sustain a fundamental value in the yen as speculators sold the currency on the likelihood that policymakers wouldn’t intervene as much. A costly endeavor by the BOJ. However, now the attention, at a relatively high level, is being placed on the Chinese yuan. With protectionist legislation targeting China likely to emerge in the US in the next week or so, Japanese officials will support a disassociation from their regional trade partner as future legislation could endanger their trade relationships as well. The underlying theme is well publicized as both Chinese and US officials continually jawbone protectionist themes on the heels of what seemed to be an ineffective strategic dialogue. On the other hand, the move would also have domestic implications as the timing of a surprise rate hike would conflict with the LDP elections in the following month. Here, central bankers would be at odds as to their national duty to follow in line with the headline government, which continues to remain monetarily “accommodative”.
However, should the central bank feel the need to profess their political independence, in line with most other industrialized central banks, this couldn’t be a better time.
Source: Bloomberg
Will This Jeopardize The Carry?
Although the overwhelming theory is one of a cataclysmic decline in the carry trade notion, there still remains the likelihood that the FX market will rebound from considerable profit taking, if it happens at all. Still offering a low cost funding vehicle, the Japanese yen will likely continue to be favored by carry traders until fundamental risk becomes too bearable in some higher yielding currencies. As a result, currencies like the New Zealand dollar, Australian dollar, and British Pound will continue to remain hot topics in the FX market as the basis point spread remains considerably wide. In the case of the New Zealand dollar, which has made one of the most impressive runs as of late, the difference between interest rates still offers the investor 725 basis points against the yen if the Bank of Japan elects to raise rates. There may be even more to come as the market continues to price in the likelihood that rates will rise further in New Zealand at the tail end of the year.
Conclusion
Given all these facts, central bankers essentially have the economic support that is required to heavily consider lifting rates in the near future. And why not? With focus turning to the overall growth of the nation and not just its consumer price component, things are looking rather interest rate bullish. The only caveat is and always has been the consumer. With wage growth still rather tepid compared to other industrialized nations, consumption continues to suppress any real rate of growth in the economy. This factor may be the only thing stopping policy makers in altering rates at the moment, leaving plenty of speculation for the months to come.
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Japan Bonds Drop for 10th Day as Greenspan Predicts Debt Slump
By Issei Morita
June 13 (Bloomberg) -- Japan's government bonds fell for a 10th day, the longest slide in three years, after former Federal Reserve Chairman Alan Greenspan predicted declines in U.S. and emerging market debt.
``Bond yields are rising globally and Japan is catching up,'' said Masuhisa Kobayashi, chief Japan bond strategist at Barclays Capital Japan in Tokyo. ``Yields look like they are pricing in an expectation for a rate increase.''
Benchmark 10-year yields in Japan reached the highest in a year after U.S. bonds slid yesterday, pushing 10-year Treasury yields to the highest since 2002. Eleven of 17 economists in a Bloomberg survey predicted the Bank of Japan will raise rates in August. The bank will hold a policy board meeting this week where it is expected to keep rates unchanged.
The yield on the 1.8 percent bond due June 2017 increased 3 basis points to 1.96 percent at 3 p.m. at Japan Bond Trading Co., the nation's largest interdealer debt broker. It earlier rose to 1.985 percent, the highest since July 4, 2006. The price fell 0.248 yen to 98.662 yen.
Twenty-year yields jumped 3.5 basis points to 2.31 percent, after reaching 2.355 percent, the highest since July 13, 2006.
Ten-year bond futures for September delivery declined 0.37 to 131.05 in Tokyo. A basis point is 0.01 percentage point.
The decline in Japanese bonds reflects the increase in borrowing costs in the U.S. and Europe, Economic and Fiscal Policy Minister Hiroko Ota said in Tokyo last week.
Widening Yield Premium
A 10-day slide in benchmark bonds was the longest since the 13 days ended June 14, 2004. The benchmark U.S. 10-year Treasury yielded 3.36 percentage points more than similar-maturity Japanese bonds yesterday, the most since Aug. 15, 2003, according to Bloomberg data. A month ago, the yield spread was about 3 percentage points.
Treasury yields have climbed faster than Japan's yields as rising U.S. consumer confidence and business activity added to expectations the economy will rebound from the slowest quarterly growth in more than four years. Traders have reduced bets the Federal Reserve will cut the benchmark rate from 5.25 percent.
``U.S. Treasuries have a lot more space to get sold off and that makes it hard for JGBs to perform,'' said Hitomi Kimura, a bond strategist in Tokyo at JPMorgan Securities Japan Co., one of 25 primary dealers obliged to bid at government debt sales.
Economists forecast the U.S. economy will expand at an annual rate of 2.6 percent this quarter, compared with 2.2 percent projected last month and a 0.6 percent pace in the first quarter, according to a Bloomberg News survey.
Inflation Outlook
The average of the yield premium of U.S. Treasuries over Japan's 10-year bonds was about 3 percentage points in the past year, Bloomberg data showed. The average reflects the difference in inflation expectations between the two countries, according to Xinyi Lu, chief strategist of the international treasury division at Mizuho Corporate Bank Ltd. in Tokyo.
``The yield spread will remain around 300 basis points because inflation expectations are stronger in the U.S. than they are in Japan,'' Lu said. Falling unemployment and rising wholesale prices in Japan are fueling inflation concerns, Lu said.
Federal Reserve Bank of Cleveland President Sandra Pianalto said this week inflation in the U.S. is ``uncomfortably high.''
The yield spread of regular Japan's conventional debt over inflation-linked bonds, known as the breakeven inflation rate, increased to as high as 67 basis points today, according to data compiled by Bloomberg. It's the highest since July 8.
Gains in short-term yields suggest traders are pricing in expectations that the BOJ will increase its target for overnight lending rates to 0.75 percent by year-end, according to Lu. Three- month Euroyen futures for December delivery yielded 1.06 percent today, up from 1.01 a week ago and 0.935 about a month ago. The bank will increase borrowing costs in August, Lu said. |
