When will the Bank of Japan exit negative interest rates?
This is a question that many Japanese investors have been eager to know since the beginning of the year. The latest answer from Japan's largest bank, Mitsubishi UFJ Financial Group, is that the Bank of Japan is expected to end negative interest rates in two weeks, and the bank has prepared accordingly.
According to the schedule, the Bank of Japan will announce the March interest rate resolution on March 19th.
The above viewpoint of Mitsubishi UFJ Financial Group is clearly much clearer than the current interest rate swap market - the latter's pricing shows that the likelihood of the Bank of Japan changing monetary policy this month is only about 50%. As of late Tuesday, the overnight index swap showed that the likelihood of the Bank of Japan raising interest rates in March is about 53%, and the likelihood of a rate hike in April is about 80%.
It is evident that if Bank of Japan Governor Kazuo Ueda chooses to change course, it is expected to have a significant impact on the Japanese government bond market and yen trend, which is as large as 1096 trillion yen (approximately 7.3 trillion US dollars).
Action in March instead of April?
"I believe it is necessary for the Bank of Japan to end negative interest rates in March instead of April," said Hiroyuki Seki, Global Markets Business Head of Mitsubishi UFJ Financial Group, in a recent interview
Seki also predicts that after the Bank of Japan's first rate hike since 2007 at its March meeting, it is likely that another rate hike will be needed - raising the policy rate to 0.25% by October at the latest to ensure future policy flexibility.
Of course, he also pointed out that the Bank of Japan "needs to ensure sufficient preparation time before the next interest rate hike.".
Seki stated that his outlook for the Bank of Japan's policy actions is based on suggestions from recent public speeches by Bank of Japan officials, as well as political and other events that may determine the direction of monetary policy this year.
Seki said that once the Bank of Japan ends the negative interest rate and starts to pay the bank reserve interest rate of 0.1%, there will be "structural changes" in the Japanese government bond market, which may lead to a decline in demand for Japanese treasury bond, thus pushing down their prices and pushing up yields.
How will Japan's largest bank layout be?
Seki said that as the Bank of Japan was expected to take action, it was holding bearish positions in Japanese treasury bond bonds through investment funds and overnight index swaps. He pointed out, "We are already managing to increase our tolerance for the rise in Japanese yen interest rates."
He stated that after the rise in short-term and medium-term interest rates, the bank will establish swap takeover positions because overnight index swaps are undervalued relative to bonds. Seki added that once the 10-year overnight index swap reaches at least 1.1% or the 5-year OIS reaches at least 0.6%, the bank plans to do so.
Seki also pointed out that if the overvaluation of Japanese treasury bond is corrected and its yield approaches the corresponding swap rate, the bank also plans to really start investing in Japanese treasury bond. According to Seki's prediction, the yield of Japanese 10-year treasury bond may tend to 1.0% or higher, and the yield of five-year bonds may rise to 0.6% or higher.
Seki also predicts that the Bank of Japan will take measures beyond just raising interest rates. When the negative interest rate policy was introduced in 2016, the Bank of Japan adopted a three-layer tiered interest rate system, which applied interest rates of 0.1%, 0%, and -0.1% to bank reserve balances held at the central bank.
Seki said that the Bank of Japan is likely to cancel the negative interest rate system while also canceling it, and the 0.1% interest rate is likely to apply to all funds in the central bank's reserves. The policy target of the Bank of Japan may also be changed to the unsecured overnight lending rate, which is expected to range from the current -0.1% to 0-0.1%.
In terms of Yield Curve Control (YCC) policy, Seki expects the Bank of Japan to maintain control over the yield curve for a period of time to curb excessive volatility after policy changes. He said, "I don't think the upper limit reference point will be cancelled. It may be maintained with greater flexibility."
How much impact does Japan's monetary policy have on the world?
It is worth mentioning that as the Bank of Japan is about to start raising interest rates, it is bound to create a sharp contrast with the policy trajectory of other major central banks around the world - including the Federal Reserve and the European Central Bank, which are expected to enter a rate cutting cycle this year.
After the Federal Reserve launched its most aggressive interest rate hike cycle in decades in the first quarter of 2022, the Japanese yen has depreciated significantly against the US dollar to around 150, as the Bank of Japan has maintained an ultra loose monetary policy in the past two years.
Regarding the latest impact of policy differences, Seki stated that as long as the US economy avoids a sharp slowdown and the Federal Reserve's actions are preemptive (meaning emergency interest rate cuts not forced due to recession), the Federal Reserve's expectation of rate cuts will not prevent the Bank of Japan from taking the opposite approach.
He also said that the bank remained cautious about foreign bond investment when the overall yield curve of US bonds would show a downward trend.
He pointed out that the end of the Bank of Japan's ultra loose monetary policy is also expected to curb Japan's long-term relaxation of fiscal discipline. He pointed to the public's concern that the central bank's massive purchase of Japanese treasury bond bonds over the years would make the government's deficit spending too loose.