Countdown to Japan's First Rate Hike in 17 Years: Which Trades Are Global Banks Betting On?
This week marks another super central bank week, with central banks in Australia, Japan, Indonesia, the US, Brazil, Switzerland, Norway, the UK, and Mexico all set to announce their interest rate decisions. While most central banks are expected to keep rates unchanged, the Bank of Japan's upcoming first interest rate hike in 17 years could determine the near-term direction of global markets.
According to Nikkei, large corporations and labor unions agreeing to substantial wage hikes in this year's negotiations have given the Bank of Japan a chance to normalize its monetary policy. The BOJ is expected to end its negative interest rate policy implemented since 2016 at its monetary policy meeting on Tuesday, marking its first interest rate hike since February 2007.
On March 15th, Japan's largest labor union, Rengo, announced the preliminary results of the spring wage negotiations, or shunto, revealing that member unions secured an average wage increase of 5.28% this year. This is not only a significant jump from last year's 3.8%, but also the largest increase since 1991, with basic wages rising by 3.7%, surpassing last year's 2.33%. Bank of Japan Governor Ueda Kazuo stated before that he was closely monitoring the results of the March shunto negotiations and would consider changing the existing monetary easing framework, including negative rates if a virtuous cycle of wage growth and price increases was confirmed.
The shunto's record-high wage increase in 33 years has strengthened the sustainability of Japan's re-inflation and the rationale for an interest rate hike at the March 19th monetary policy meeting. Following the announcement of the first-round results last Friday, the probability of a rate hike by the Bank of Japan in March has already been priced at 70% in the swap market. Additionally, it is expected that the BOJ's short-term policy rate will gradually rise towards 0.25% by late 2024, up from its current level of minus 0.1%.
According to Goldman Sachs economist Tomohiro Ota,“these developments imply that the BOJ probably no longer needs more data for the policy change, nor to wait to justify the policy change with the quarterly Economic Outlook report in April.”
Under its negative interest rate policy implemented since 2016, the BOJ has been charging a 0.1% fee on financial institutions' excess reserves held at the Bank to guide short-term borrowing costs to slightly below zero. Regarding the expected exit from negative rates, BOJ Deputy Governor Maaya Uchida recently stated that the policy rate could be raised by 20 basis points to 0.1%, meaning that the central bank applied a 0.1% interest rate to the excess reserves in current accounts held by financial institutions at the Bank. This move is expected to guide the uncollateralized call rate in the money market to hover in the range of 0 to 0.1%.
In addition to the potential interest rate hike, the market is also closely watching the Bank of Japan's stance on future rate hikes, its management of asset purchase programs, including ETFs, and the flexibility of its new bond purchase program, as a more flexible program would make it easier for the central bank to undertake quantitative tightening (QT) in the future.
According to Maaya Uchida's previous statements, the BOJ will stop purchasing risky assets, such as ETFs and REITs, once it judges that achieving the 2% inflation target is within reach. However, the central bank will not significantly reduce its purchases of government bonds, and will ensure that long-term interest rates do not spike suddenly after ending YCC.
Currently, the BOJ's regular monthly bond purchase amount is around 6 trillion yen ($40.7 billion). Goldman Sachs predicts in its latest report that the Bank of Japan may announce an end to YCC, but will make some commitments, such as continuing to purchase government bonds at the current pace or promising to intervene with large-scale purchases when yields rise sharply. However, the Bank of Japan is ultimately expected to slow down its bond purchases to reduce the size of its massive balance sheet.
Regarding asset purchases, some analysts believe that while buying ETFs has supported stock prices to some extent, it has also distorted market pricing. Sources say that Japanese officials believe that with Japanese stocks recently hitting record highs, there is no need to continue purchasing ETFs to limit risk premiums, and the Bank of Japan may stop buying such risky assets after exiting its ultra-loose policy. It is worth noting that the Bank of Japan only purchased ETFs three times last year and did not intervene in the market after the stock market fell last Monday, whereas in the past, the bank usually bought ETFs when the stock market fell 2% or more in the morning. The central bank's reluctance to buy more ETFs became even more apparent during the Japanese stock market's pullback in the first half of March.
Before the Bank of Japan meeting, some fund managers have already started exploring investment opportunities in the Japanese market, with buying certain Japanese stocks, increasing short positions on government debt, and betting on a stronger Japanese yen as the main trades.
○ Bullish on Japanese stocks:
The $Nikkei 225 (.N225.JP)$ is one of the best-performing indices globally this year, but its upward momentum has weakened since it first broke through the 40,000-point mark in early March. Looking ahead, some analysts believe that despite the shift in monetary policy, Japanese stocks still have support, as 1) the path to exiting negative rates may be more gradual and cautious, limiting the upward potential for the yen; 2) corporate earnings growth has been a significant factor driving the earlier rally in Japanese stocks; 3) Japanese stocks have attractive valuations, with about half of TOPIX stocks trading at a P/B ratio below 1x; 4) the positive impact of US stocks on Japanese stocks.
From a stock selection perspective, many analysts favor banking and insurance stocks, which are expected to benefit from the boost of higher interest rates on their earnings. Decades of ultra-low rates have previously compressed interest income for lending institutions. Meanwhile, Morgan Stanley analyst Makoto Furukawa also pointed out that as the Japanese yen rises, the trends of domestic and foreign-oriented stocks will reverse. Previously, the continuous weakening of the yen mainly drove the rise of foreign-oriented stocks. However, from the perspective of future profitability, domestic-oriented stocks that rely more on the overall condition of the Japanese economy have more room for growth. If the benign cycle of rising prices and wages can continue, the market may gradually favor cyclical strategies. BlackRock prefers a wider investment in the Japanese stock market and bets on profitability in the technology, construction, and lending sectors.
○ Bearish on Japanese bonds:
The rising expectations for interest rate hikes have deepened the short position of Japanese bonds. Since the beginning of the year, the $Japan 10-Year Treasury Notes Yield (JP10Y.BD)$ has risen by about 13 basis points to around 0.76%. UBS Asset Management and Schroders were among the early players to establish short positions on Japanese bonds, while RBC BlueBay recently joined the short position camp and is shorting 10-year government bonds as its largest macro bet. In addition, Abrdn has reduced its position in Japanese government bonds in its global government bond strategy.
○ Bullish on Japanese yen:
Under the long-term negative interest rate policy, the wide interest rate spread between other developed countries and Japan made shorting the yen very common. However, now with the strengthened expectation of interest rate hikes, some institutions including Schroders Investment Management and JPMorgan have opened long positions on the yen to benefit from the expected appreciation.
Rock at British asset manager abrdn stated, "We expect the tightening of monetary policy to herald a period of strength, with appreciation somewhere in the region of 8 to 10% for the currency versus other majors over the next calendar year."
Source: Bloomberg, Nikkei Asia, MacroMicro
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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