JPY: Underwhelming BOJ policy tweak could bring more yen weakness
There was a lot of speculation about a possible policy tweak going into the Bank of Japan meeting today. A Nikkei report from the night before said that the BOJ is set to consider a further adjustment to its YCC framework at Tuesday's monetary policy meeting, potentially allowing 10-year Japanese government bond yields to rise above 1%.
However, the BOJ underwhelmed yet again with only a marginal change to policy settings. The central bank added flexibility to its yield target, with the 1% target for 10-year yields now a “reference” rather than a strict target. The negative interest rate policy was left unchanged. The adjustment gives BOJ more optionality as market continues to test its limits. Had they simply raised the target to say 1.5%, yields would have likely quickly risen to test that as well and that would mean more BOJ purchases making the move costly.
The BOJ also raised its inflation outlook for FY 2023, 2024 and 2025 to 2.8% (from 2.5%), 2.8% (from 1.9%) and 1.7% (from 1.6%) respectively. Given that the central bank still expects inflation to return below the 2% target range by FY2025, it seems they still do not buy the idea that inflation could be sticky. That suggests that they will wait for wage negotiation results in early 2024 before any major policy tweaks.
USDJPY was disappointed with the subtle BOJ move and returned to 150+ from 148.81 lows after the Nikkei report raised speculation of a tweak earlier. The break of 150 last week proved that the level is not a line in the sand, and traders may be ready to push the limit on that. However, event risk from FOMC is also ahead in the week, so expect 152 to cap USDJPY for now. If Fed stays on higher-for-longer, USDJPY could be poised to touch 155 levels, however a dovish turn from the Fed could bring the pair down to back below 148. Medium-term, outlook for yen remains positive given the valuation discount, Fed shift to a dovish policy and a likely calibrated YCC removal, but traders may not be ready to bet on that yet given the huge yield differential and the carry advantage of the US dollar.
Market Takeaway: Dip buyers could continue to bring USDJPY higher to test 152 as BOJ underwhelmed expectations of a policy change. Fed risks ahead mean moves could be measured for now.