Market Drivers September 21, 2016

BOJ turns policy to Yield curve
UK PSNB in line
Nikkei 1.91% Dax 0.93%
Oil $45/bbl
Gold $1322/oz.

Europe and Asia:
JPY BOJ keeps rates at -0.1% but announces yield targeting
GBP UK PSNB 10.1B vs. 10.5B

North America:
USD FOMC 14:00

The Bank of Japan today announced a series of novel measures to stimulate the Japanese economy and combat deflation but in the end the currency market was not impressed and USD/JPY returned to trade below the 102.00 level after briefly spiking to 102.75 in the wake of the news.

Amongst the more unusual aspects of today’s policy announcement was the change of course by the BOJ from standard QE buying of bonds towards a more flexible approach of targeting the long term yields on the 10 years JGBs. The BOJ stated that it will use unlimited funds to keep the JGB 10 year yield above the zero level. In response the JGB yields spiked to 0.005% but then quickly dropped and turned negative once again to -0.023%.

The focus on the yield curve was a tacit admission by the BOJ that the current program of negative interest rates was not working. The BOJ hoped that a turn towards negative short term rates would spur lending by Japan’s banks, but the opposite has occurred. The NIRP policy has greatly reduced the profitability of the financial sector and has as result actually forced banks to hoard cash at an even greater scale.

Therefore, so far the BOJ policy has proved counterproductive and today’s policy change was an attempt to rectify those mistakes. By making sure that the yield curve steepens the BOJ will help increase the profitability of the financial sector which typically borrows short and lends long and that in turn should allow banks to loosen their lending standards to better comply with BOJ’s monetary transmission mechanism.

Although the BOJ made it abundantly clear that they intend to achieve their yield target, the market remain dubious about the central bank’s ability to actually do what they say. With JGB yields now below the zero mark, the next several days will become a test of BOJ’s new policy and if it fails to reach its mark USD/JPY could drift towards 100.00 as disappointment creeps in.

The BOJ of course is constrained not only by its own policy limits, but by the action the Federal Reserve which meets later today to announce its rate decision. The conventional wisdom is that the Fed will remain on hold this month, but the key focus will be on forward guidance. If the Fed makes it clear that rates will rise in December USD/JPY could stage a second rally of the day and test the key 103.00 level in response to Fed’s more hawkish posture. However, if the Fed remains non committal the prospect of USD/JPY parity before the end of the day becomes a real possibility.

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