31 October 2018
The Bank of Japan has taken only baby steps toward normalisation, in contrast with the U.S. Federal Reserve’s hiking cycle. A full exit from the BOJ’s massive stimulus remains nowhere on the near-term cards, and Japan’s central bank reiterated on Wednesday that it intends to maintain interest rates at their “extremely low levels” for “an extended period of time.”
But small steps for Japan’s central bank could be big steps for its currency. The most important inflection point for the yen’s long-term direction came in late July, when the BOJ stated it would carry out its massive purchase of Japanese government bonds (JGBs) in a more ‘flexible manner,’ and would allow long-term interest rates to fluctuate depending on economic and market developments.
We view the BOJ’s adjustment to yield curve control as a new framework for beginning the long ‘normalisation’ of monetary policy, which should put upward pressure on the yen relative to its major peers. The yen is around 20 per cent cheaper than the US dollar according to our long-term FX fair-value model that considers inflation, productivity growth and terms of trade.
Signs of strength in the Japanese economy show it is breaking out of its multi-decade quagmire into a new regime, providing evidence to back the BOJ’s shift toward greater flexibility.
While inflation remains shy of the bank’s ambitious 2 per cent target, it is solidly higher, with Tokyo’s core consumer price index (CPI) - seen as a leading indicator of nationwide price trends - rising 1.0 per cent in October from a year earlier. If nationwide core inflation breaches the key 1 per cent level over coming months, this might embolden the BOJ to further adjust its yield curve control in a hawkish direction.
Under its current yield curve control policy introduced in 2016, the BOJ has been guiding short-term interest rates to around minus 0.1 percent, and the 10-year JGB yield to around zero percent. Local media in Japan have reported that the BOJ is considering further adjustments to its bond-buying, to allow market levels to better reflect fundamentals - and revive a debt market in which trading and liquidity have all but evaporated due to the central bank’s buying.
Partly due to that low liquidity, the BOJ has been doing what some call ‘stealth tapering’ in recent years, far undershooting its self-described ‘loose’ annual purchase target of 80 trillion yen (USD $710 billion). It has kept this target intact, but is on track to buy less than half that amount this year - implicitly doing what the European Central Bank explicitly began to do this month as it took steps to terminate its bond-buying program at the end of this year.
If the BOJ decided to allow the 10-year yield to drift above 0.2 per cent in a controlled manner, that development would be very positive for the yen.
So even as the BOJ maintains its lip service to keep accommodative policy until it eventually meets its elusive 2 per cent inflation target, the JGB market will reveal the bank’s true intentions, in both the amount of bonds it buys and the extent to which it permits yields to move. As the latter has implications for the currency, we therefore need to pay close attention not only to what the BOJ says but also to what it does, as the two aren’t a perfect match.
The value of investments and the income from them can go down as well as up so you may get back less than you invest. Past performance is not a reliable indicator of future results.
These materials are provided for information purposes only and are intended only for the person or entity to which it is sent.
These materials do not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities or investment product.
Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.
Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. They are valid only as of the date indicated and are subject to change without notice.
This material was created by Fidelity International. It must not be reproduced or circulated to any other party without prior permission of Fidelity.
This communication is not directed at, and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity is not authorised to manage or distribute investment funds or products in, or to provide investment management or advisory services to persons resident in, mainland China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers.
This content may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content.
Fidelity International refers to the group of companies which form the global investment management organisation that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice personal recommendations based on individual circumstances.
Issued in Europe: Issued by FIL Investments International (FCA registered number 122170) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG, authorised and supervised by the Swiss Financial Market Supervisory Authority FINMA. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus. For German institutional clients issued by FIL Investments International – Niederlassung Frankfurt.
In Hong Kong, this content is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road, Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C. Customer Service Number: 0800-00-9911#2.
Issued in Australia by Fidelity Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). This material has not been prepared specifically for Australian investors and may contain information which is not prepared in accordance with Australian law.