I am back from a three-week holiday today and a look around the currency market shows a remarkable lack of volatility in much of the G10 space outside of JPY crosses – more on that below as we await a possibly pivotal Bank of Japan meeting tonight.
Elsewhere, emerging markets have rallied as global risk appetite has recovered and EM credit spreads have improved dramatically. Providing an interesting counterpoint to this EM development is China’s devaluing of the CNY, which maintains an impressive pace even as Chinese officials recently dusted off claims that they won’t pursue a devaluation policy.
The week ahead
Bank of Japan tonight: last week’s jump in Japanese government bond yields garnered considerable attention on reports citing official BoJ sources that the Bank is planning possible tweaks to its policy regime. The argument is that nothing the BoJ has done has brought the inflation target into view and that the largely flat yield curve out to 10 years (where the Bank effectively maintains a 10-12 basis point “ceiling”) is bad for the financial sector – i.e. may limit credit to the economy.
Remember that it was ironically the 10-year’s collapse well below 0% that first prompted the Bank of Japan to implement the yield curve control policy in 2016. The BoJ was forced to mobilise unlimited purchases of JGBs last week to defend the 10-year yield ceiling around 11 basis points and any move to loosen up its commitment to that ceiling could trigger at least a chunky one-off gapping move in global bond markets that would prove JPY-positive and likely risk-negative for global markets.
Whether the BoJ tweaks policy or not, none of the potential policy options are likely to move the needle for the Japanese economy or inflation.
USDJPY has traded down in the pivotal 110.50-111.00 zone ahead of a potentially significant central bank meeting, where a gap risk is large on any notable policy tweak from Kuroda and company could quickly take the pair down through the last short-term supportive zone just below 110.00.
The Bank of Japan detests volatility, but when a ceiling-like situation is in play, it is difficult for the BoJ to avoid an either-or setup (large gapping move) for long-dated JGBs and the yen.