A hidden force could soon be released by BoJ

Bank of Japan decision could unleash selling of foreign assets

Today at 1800 GMT the FOMC could surprise the majority of economists with a 75 basis points rate hike as between the lines leaked in the Wall Street Journal yesterday (perceived to be the primary source for the Fed to leak information). The market has already priced in a 75 basis points rate hike with a 90% probability so if the FOMC wants to be in line with the market and retain its credibility it must follow through. Despite the Fed Funds Rate futures are pricing in a 75 basis points rate hike the equity market in particularly is not prepared. We still observe a high degree of complacency among retail investors still exhibiting buy-the-dip mentally and that things will soon normalize. They are in for reckoning.

One thing is the Fed’s need to move fast but even more importantly other central banks such as BoE, ECB, and BoJ must change cause or else creating a far bigger problem down the road. Maintaining a too loose monetary policy vs the Fed will weaken the GBP, EUR, and JPY against the USD importing even more inflation as the world’s natural ressources are priced in USD. Bank of Japan is probably the central bank with most at stake and Kuroda has fought hard to maintain its yield-curve-control (YCC) with its 25 basis points upper limit on the Japanese 10-year yield. The policy is becoming to costly now for Japan that import too much inflation due to its weaker currency (see chart) and weakening the credibility of BoJ. If BoJ breaks away from its YCC policy then a hidden force will be unleashed.

Japan has a large net international investment position (NIIP) which has risen dramatically since 2017 which was introduced in September 2016 reaching 70.7% of GDP by September 2021 up from 59.5% in 2017. These foreign assets represent $3.4trn. If Bank of Japan pivots on its monetary policy we could see a large reversal of the JPY which in theory could increase the propensity of Japanese investors to sell their foreign assets. Japanese investors have recently been the main source of selling in Danish mortgage bonds suggesting some “smart” investors are anticipating the death of the YCC policy. An eventual policy pivot by Bank of Japan could unleash large selling pressure in USD and EUR assets, so Friday’s rate decision in Bank of Japan is crucial to monitor for investors.