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This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe
Wednesday, December 21, 2022
Traders faced one more surprise late Monday to cap off a volatile year: a surprise change in monetary policy from the Bank of Japan.
The BoJ announced a tweak to its yield curve control policy, saying it will now allow the yield on 10-year government bonds to rise to about 0.5%, up from a previous cap of 0.25%. The central bank is still targeting a 0% rate on its 10-year bond and maintained a -0.1% benchmark interest rate.
A “nasty early Christmas surprise,” the Wall Street Journal dubbed it. “Bank of Japan stuns markets,” the Financial Times blared. Bloomberg News called it a “shocker.”
Indeed, currency and rates markets reacted accordingly, with the Japanese yen (JPY=X) surging 4% versus the U.S. dollar, and the U.S. 10-year Treasury yield leaping by more than 10 basis points.
For markets, the big deal is the Bank of Japan hadn’t joined the global central bank tightening party until now, and its project of maintaining low-and-stable monetary policy has been one of the longest-standing in the world.
BoJ Governor Haruhiko Kuroda said in a press conference following the decision that this move still doesn’t signal tightening, but rather a continuation of the bank’s yield curve control policy. Kuroda is due to step down from his post in April.
Amidst all the excitement, U.S. stocks largely shrugged.
“The modest move higher in Japanese rates is important for FX markets, but it will not have any impact on the shape of the U.S. economic outlook,” wrote Torsten Slok, chief economist at Apollo Global Management, in a note to investors.
One of the concerns with a potential rise in rates in Japan is that Japanese investors would pull money from foreign assets amid the prospect for better returns at home.
Slok suggests the effect would be negligible, however, with Japanese holdings of U.S. long-term Treasury bonds accounting for just 5% of the total. For U.S. corporate bonds and U.S. equities, Japanese holdings comprise just 2% and 1% of the total, respectively.
Another risk when there’s a market surprise is that it could trigger some kind of “blowup,” said Steve Sosnick, chief strategist at Interactive Brokers.
In particular, those employing a “carry trade” could have been vulnerable following the Bank of Japan’s announcement. As Sosnick explained in a blog post, “The trade involves borrowing a low yielding currency — typically the yen — and using the proceeds to purchase higher yielding fixed income assets or to finance speculation in equities and other risk assets. In theory, those who had the carry trade on should be getting clobbered with the yen rising dramatically.”
But there was no evidence of that clobbering in the market, he said, perhaps because the yen had already been moving higher, or maybe because hedge funds were repositioning into the end of the year.
Indeed, the rise in the yen could actually end up being good news for U.S. stocks, making this “nasty early Christmas surprise” one to the upside.
Since it reached its high versus the yen on October 20 of this year, the dollar has fallen by about 12%. That kind of move tends to presage a stock rally, analysts at Bespoke Investment Group wrote in a note on Tuesday.
Looking at other instances when the yen rallied by at least 10% versus the dollar over a two-month period, Bespoke found stocks were higher a year later in every instance since 1978, and had only risen by less than double-digits twice.
“One month later, the S&P 500 was only higher 62% of the time, but three, six, and twelve months later, U.S. stocks rallied 85% of the time,” they said.
“When the headline hit, my reaction was probably like a lot of other people’s reaction, which was – whoa!” Sosnick said. “It was shocking, but ultimately not a reason to freak out.”
What to Watch Today
7:00 a.m. ET: MBA Mortgage Applications, week ended Dec. 16 (3.2% during prior week)
8:30 a.m. ET: Current Account Balance, Q3 (-$222.0 billion expected, -$251.1 billion during prior month)
10:00 a.m. ET: Existing Home Sales, November (4.20 million expected, 4.43 million during prior month)
10:00 a.m. ET: Existing Home Sales, month-over-month, November (-5.2% expected, -5.9% during prior month)
10:00 a.m. ET: Conference Board Consumer Confidence, December (101.0 expected, 100.2 during prior month)
10:00 a.m. ET: Conference Board Present Situation, November (137.4 during prior month)
10:00 a.m. ET: Conference Board Expectations, November (75.4 during prior month)
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