Summary
The Bank of Japan formally exited its negative interest rate policy and raised rates for the first time in 17 years. Nonetheless the extent of policy normalisation is expected to be fairly limited and the USDJPY is unlikely to see strong downward momentum in the near term. The investment case for Japanese equities remains solid given the numerous longer-term structural tailwinds.
The Bank of Japan (BoJ) has finally ended eight years of negative interest rates by raising the policy rate to +0.1%. This is Japan’s first interest rate hike in 17 years. But the fact that the rate is still near zero highlights BoJ’s decision to remain cautious in view of the economy’s fragile recovery.
Other than raising rates, BoJ is discontinuing the yield curve control (YCC) policy that was adopted in 2016. The YCC policy had allowed BoJ to cap the yield on 10-year Japanese government bonds at 1%. It is also halting purchases of exchange traded funds, all part of its quantitative easing programme.Nonetheless BoJ has said that it will continue to buy government bonds at its current pace to stop yields from rising sharply. This indicates that BoJ intends to maintain its accommodative policy stance.
According to Ivailo Dikov, Head of Japan Equities at Eastspring Investments, BoJ’s move is very much in line with market expectations. Bank stocks saw some weakness post the announcement. However, overall moves have not been significant as the announcement did not come as a big surprise.
Going forward, we may see a stronger yen if the BoJ gets more hawkish and the US Federal Reserve (US Fed) more dovish. A stronger yen will impact Japanese exporters; we may see softness in autos, materials, tech and machinery stocks. On the flipside importers will benefit. But we believe that even if the yen strengthens back towards 130 against the USD, it is still a comfortable level for most exporters. On the flipside, importers will benefit.
More importantly, the focus will be on BoJ’s next policy move and whether further tightening can be expected in second half of the year. This will depend on economic fundamentals, including real wage growth, domestic demand, etc. If inflation and growth start to prove more sustainable in BoJ’s eyes, this should be viewed as a positive for both consumer and investor sentiment. We do not see the normalisation of monetary policy undermining the long-term investment case for Japanese equities given the numerous longer-term structural tailwinds. We continue to focus on bottom-up drivers including corporate governance reforms and pricing discipline at companies.
Goh Rong Ren, a Director in Eastspring’s Fixed Income Team believes that the extent of BoJ’s policy normalisation is likely to be fairly limited. Thus, future broader USDJPY moves will be driven by the US Fed’s rate cutting trajectory. This is especially so given that USDJPY correlates very well with US-Japan interest rate differential.
A strong US economy and stalling disinflationary momentum over the last couple of months have recalibrated market expectations of swift rate cuts from the Fed. US yields are thus unlikely to move meaningfully lower in the near term. This in turn will provide support for the USDJPY level. Furthermore, with the interest rate differential between the US and Japan in excess of 5%, the JPY remains an ideal funding currency vis a vis the USD.
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