Yen Rally Seen at Greater Risk From Fed Hawks Than BOJ Twists

What Can We Expect From the BOJ?
  • Japan’s currency is best performer among G-10 peers this year
  • Central banks’ policy meetings grab foreign-exchange spotlight

As bond investors remain glued to their screens for the Bank of Japan’s policy-review decision on Wednesday, yen traders may be looking to the Federal Reserve’s announcement hours later.

Japan’s currency is set for three straight quarters of gains -- the longest rally since 2011 -- in the wake of the BOJ’s decisions to leave its bond-buying program unchanged in July and to adopt negative rates in January.

Whether BOJ Governor Haruhiko Kuroda decides this week to widen the gap between long- and short-term yields, or to cut rates, currency strategists say the biggest threat to the yen would be signs of hawkishness from Fed Chair Janet Yellen. During the past two years, the yen has had a greater tendency to move with changes in U.S. short-term yields than with those in Japan, data compiled by Bloomberg show.

“That’s going to be a problem in terms of trading dollar-yen on the back of the BOJ in the next 24 hours,” Jeremy Stretch, head of foreign-exchange strategy at Canadian Imperial Bank of Commerce in London, said in an interview on Bloomberg Television. “It’s difficult to look at the BOJ in isolation as the Fed’s direction is going to be hugely influential. We expect the BOJ to take rates more into negative territory. Is it going to be enough to cheapen the yen significantly? Possibly not.”

The yen gained 0.2 percent to 101.70 per dollar as of 5 p.m. in New York, and is up 18 percent this year, the best performance among its Group-of-10 peers, amid speculation the BOJ is running out of policy ammunition as it seeks to spur inflation through unprecedented monetary easing.

Kuroda’s decision to cut rates to minus 0.1 percent in January set off a rout in banking stocks and a flight to the yen as a haven. Gains in the Japanese currency accelerated at the end of July when the BOJ underwhelmed markets with stimulus measures that fell short of analysts’ expectations.

The yen’s bull run paused last month as traders shifted their focus to the prospect of the Fed raising rates. Japan’s currency depreciated 1.3 percent in August, halting a two-month advance, as the chance of a 2016 hike surged to more than 60 percent. That’s after Yellen told a symposium in Jackson Hole, Wyoming, that the case for tightening policy was getting stronger.

Message Received

“The message has been conveyed that the BOJ wants to steepen the long-end of the curve, but the baseline is the pace of U.S. rate hikes,” said Shinsuke Sato, head of the currency trading group at Sumitomo Mitsui Banking Corp. in Tokyo. “The dollar’s uptrend won’t resume if the Fed’s rate hike pace is once a year. A steepening Japanese yield curve, whether or not the BOJ deepens the negative rate, won’t bring back the yen weakening trend.”

The yen will end 2016 at 105 per dollar, according to the median estimate of more than 60 analysts surveyed by Bloomberg. In January, the year-end forecast was 125.

JPMorgan Chase & Co. sees a slide to 103 and Sumitomo Mitsui Banking’s head of research, Yoichiro Yamaguchi, forecasts a drop to 105. CIBC predicts 104.

The yen and two-year Treasury yields -- among the most sensitive U.S. securities to monetary policy expectations -- showed a correlation of about 0.5 during the past two years, data compiled by Bloomberg show. A zero reading would indicate no link between the two while 1 would indicate they moved in lock-step. The yen and two-year Japanese yields had a correlation ratio of 0.08.

Heading into the BOJ and Fed policy meetings on Tuesday and Wednesday, options traders are showing a revival in bullish yen sentiment. The premium for contracts to buy the yen versus the dollar in one month, over the cost of those to sell, was at 0.6, after disappearing in late August. Speculators boosted net bets on gains in the Japanese currency to 56,846 contracts last week, close to the record high of 71,870 in April.

The yen may strengthen after the decision, even if the Japanese central bank undertakes further easing, according to Eric Viloria, a currency strategist at Wells Fargo Securities LLC.

“The yen has been strengthening this year and some of that strength has occurred around easing,” Viloria said. Past easing policies from the Japanese central bank "were considered underwhelming, so it depends on expectations."

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