BoJ policy may over-shadow Fed - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that the case for a stronger USD recently has more to do with the likelihood that the BoJ implements a reverse policy twist, tending to weaken the JPY and place more upward pressure on longer-term yields.

Key Quotes

“Long-term yields arguably still have some ways to rise from what may be irrationally low levels driven by negative 10-year yields in Japan and Germany.

Few major central banks yet see much evidence that inflation pressures are rising.  There is some risk in the USA, hence the discussion is about hiking.  There is inflation brewing clearly in the UK following the steep fall in the GBP this year, but this is viewed more as transitory and the BoE is focused on dealing with the Brexit fallout to investment and confidence in the UK.

Policy easing biases remain in the Eurozone, UK and Japan.  However they are seeing limitations or costs to monetary policies and the market is beginning to revise down expectations of more easing, especially bond buying programs.

The BoJ policy meeting hours before the FOMC meeting is set to wind back its long-term JGB purchases.  We expect it to present this in conjunction with a deeper negative overnight interest rate target.  This may tend to weaken the JPY and it should steepen the Japanese yield curve; in particular with higher long-term yields.  We see this placing further upward pressure on global bond yields, triggering some further correction in emerging market assets and currencies.

How long this lasts may depend on how much global bond yields rise.  At some point, the BoJ will still use its bond-buying capacity to prevent an excessive rise in yields.  However, the weaker is the JPY, implying easier policy and higher inflation expectations in Japan, the more the BoJ will allow its yield curve to steepen.  The higher Japanese yields rise, the higher global bond yields may rise, and the bigger the potential fall-out to global asset markets as investors reverse some of their recent run-up in exposure to higher yielding riskier assets.

As such, we see the performance of USD/JPY having significant implications for other currencies and the broader performance of the USD.”