Implications of BoJ's new operations and FOMC – Deutsche Bank

Masao Muraki, Global Financial Strategist at Deutsche Bank, lists down the key implications of the BoJ’s new operations and recently concluded FOMC meet.

Key Quotes

“Trump market enters stage two: Rates and forex breaking out of ranges

Following the FOMC meeting, UST yields and the dollar index broke above the top of their ranges thus far. It appears the Trump market has entered its second stage. Consensus trades targeting higher yields and a stronger dollar have consistently failed, but the market theme is now shifting from dependence on monetary easing to dependence on fiscal expansion. We forecast that 2017 will bring a faster pace of US economic growth, rising interest rates, and a stronger dollar. While we see alternating risk-on and risk-off phases continuing, we think stronger inflation expectations will dictate the market's direction.”

“BoJ curbs rise in yields

Just after 10am on 14 December, the BoJ announced its offer for outright purchases of JGBs. It increased purchases in the 10y-25y and 25y+ sectors by ¥10bn each versus the previous operation. The BoJ gave advance notice that it would make the next offer for 10y or greater maturities on 16 December. This marks the first increase in purchase amount since September's comprehensive assessment. It is also unusual for the Bank to telegraph its next operation. Japanese super-long yields fell back following the announcement. The operation was probably intended to avoid the risk of the 14 December FOMC meeting triggering an upset at the 15 December 20y JGB auction, against a backdrop of rapidly rising super-long yields.”

“Weak yen prior to new US government makes sense 

We think the shift to a weaker yen makes sense in terms of forex policy in the transition period between governments, when verbal interventions tend to be avoided. We believe the Trump government is likely to verbally intervene and strengthen pressure via the G7/G20 following its 20 January inception. Japan's yield curve control policy could also draw fire since it acts to weaken the yen when US interest rates are rising.

The yen has fallen more sharply than the euro or pound following the US presidential election. We think this is because the BoJ has used yield-curve control to suppress a rise in long-term rates. Compared with Europe, Japanese yields (particularly 10y) have risen only slightly. 

President-elect Trump has been sharply critical of China and other nations' forex policy, and has commented that he sees excessive dollar strength as an issue.”

“Pressure for stronger yen/higher long-term JGB yields after Trump inauguration 

Following President Trump's inauguration, we forecast a reversal in recent yen weakness, and reduced forex sensitivity/increased JGB yield sensitivity to rising UST yields. We also think it will be more difficult to implement fixed-rate purchase operations, which could draw criticism as a form of forex policy. Furthermore, greater pressure to redress dollar appreciation could require adjustments to yield-curve control. However, raising the 10y JGB yield target could prompt speculation about further hikes and lead to the risk of a rapid increase in yields. We think the options would be to maintain the yield target at around 0% while tolerating an overshoot in long-term yields and an undershoot in the pace of monetary base growth.”