FX: Ahead of BoJ September

The Bank of Japan (BoJ) monetary policy meeting, due for release at some stage on September 19th, appears far more cut and dry then The Fed's decision which sees daylight at 4am AEST Sep-19.

The majority of markets, at time of writing, are convinced that the BoJ will hold tomorrow, with futures implying a 92% probability of no change to Japan's short-term policy rate - currently sitting at -0.10%.

For those unaware, The BoJ target not only its short-term rate (like most central banks) but also its 10y yield, under what's called Yield Curve Control (YCC), as a way of maintaining the shape of their yield curve. A target of 0% is set for its 10y yield with a flexible bandwidth of +/- 0.2% either side of it. This means that the BoJ stand ready to act as buyers/sellers in the market in order to keep the 10y yield within its targeted range.

To summarise, in line with market expecations, I believe the BoJ is most likely to: 

 

However, I think there is a slight sense of wait-and-see for The BoJ depending on what The Fed do and how USDJPY reacts to The Fed's expected rate cut. If USDJPY weakens significantly post Fed - that is, the Yen strengthens - it could implore The BoJ to unleash a more dovish announcement in a bid to deny markets of any unwelcomed Yen appreciation.

Historically, Yen appreciation has been strongly correlated in certain periods with weaker Japanese equities due to Japan's export status, think Sony or Honda. Japanese multinationals are hurt by the negative effect on exports from a stronger Yen, given that a stronger Yen reduces demand for Japanese products  (because it's more expensive in foreign currency terms) and therefore weighs on corporate revenues. The BoJ will want to avoid the disinflationary wage effects of a weaker stock market. 


USDJPY (purple, LHS) and Nikkei Futures (orange, RHS). Source: Eikon

If The Fed do implore The BoJ to switch gears and protect itself against Yen appreciation, I think that's more likely to manifest in: 

As oppose to a further rate cut given most of Japan's yields (short-term and long-term) are currently in negative territory. 

 

Fundamentally, with The Fed looking most likely to cut 25bps (65% priced in) and The BoJ appearing to hold (92% priced in), I'm inclined to reason that this central bank divergence base case plays out with USDJPY trading down below 108 and testing support levels 107.4 and 107. 

As a thought experiment, let's say The Fed cuts. We'd see markets bid into US fixed income, pricing in an extra 35% of a 25bps rate cut, therefore bringing bearish pressure onto USDJPY as markets reverse carry. If The Fed undergo a hawkish cut, there won't be as much bearish pressure on USDJPY but still likely more than what we're currently seeing.

Now on the other side, if BoJ hold, markets should read into this as relatively more hawkish and lean on USDJPY bearishness (Yen strength). However, should the BoJ react to the Fed, thereby imploring it to be more dovish in its response, it's still highly unlikely that the BoJ cut but instead utilise other monetary tools. In this case, the balance of risks in my view still lean on USDJPY bearishness.  

Furthermore, technically, USDJPY has retraced from August lows (below 105) to a key Fibonacci level in 76.4% which could see strong resistance. While momentum on the slow stochastic looks to also be turning. 

In combination, the fundamentals and technicals for tomorrow's BoJ monetary policy meeting in my view lead to a weaker USDJPY with support around 107.4 (July lows) and 107 (June lows). As a final note, I'd also be negative Japanese equities through the day due to Yen appreciation.  


USDJPY, daily candlesticks. Source: Eikon