Traders have warned that bond and currency markets face a turbulent week as the Bank of Japan meets for the last time before a new governor is named and faces intensifying pressure to abandon its yield curve control policy.
The two-day monetary policy meeting will take place on Tuesday and Wednesday. The open market is considering the ramifications of Japan finally moving away from the ultra-loose policy that has established a 20-year war with deflation and made it a global source of cheap financing.
The bank spent about 5 percent of Japan’s gross domestic product to maintain its yield target last month.
Analysts say the likelihood of a major announcement at this week’s meeting has increased as Haruhiko Kuroda is set to step down in April after a record 10 years as BoJ governor. This meeting was effectively his last chance to crystallize his legacy.
Traders are considering three possible outcomes for the bank’s policy path.
In one scenario, the central bank further loosens its target ceiling on 10-year Japanese government bonds – a tactic it adopted in December aimed at addressing deeper dysfunction in the market.
The BoJ surprised investors last month by announcing that it would allow the 10-year bond yield to fluctuate by 0.5 percentage points above or below the zero target, replacing the previous band of 0.25 percentage points.
Since investors have challenged the resolution of Kuroda, with the yield on the 10-year JGB rising above the target band to 0.53 percent on Friday.
Masatoshi Kikuchi, chief equity strategist at Mizuho Securities, said ahead of this week’s meeting that the situation was “ripe” for tactical JGB selling by foreign macro hedge funds that benefited from the BoJ’s revision of yield curve controls in December.
The central bank has spent a total of ¥27tn ($211bn) in record bond purchases to defend the newly set ceiling. The bank has about half of the JGB market thanks to the YCC policy, which started in 2016.
Economists said the central bank could cut rates twice in December and raise the 10-year yield ceiling to 0.75 percent or as much as 1 percent.
Koichi Sugisaki, a macro strategist at Morgan Stanley MUFG, said the widening of the YCC should reduce the pressure on the BoJ to continue buying large bonds, estimating that the 10-year JGB yield should, under normal conditions, trade around 0.58 percent considering that 10. -Yield US Treasury was at 3.5 percent.
Citigroup economists have predicted the second scenario, the BoJ completely abandoned the YCC. In doing so, Kuroda will step aside his as-yet-unnamed successor for the job.
“It seems better to carry out major operations under the old regime so that the new governor can carry out policy management more freely from April,” said Citigroup economist Kiichi Murashima.
A third scenario, supported by economists at UBS and Nomura, is for the BoJ to make no changes to policy as it has to wait and see until the market digests the impact of the December revision.
“For the BoJ to officially end the YCC, it needs to reach a point where 2 percent inflation is sustainable and if that happens, it also means negative interest rates will no longer be needed,” said Naka Matsuzawa, chief Japan macro strategist at Nomura. “You can hardly apply all this logic with this week’s meeting.”