2023-08-09 02:09:17
The Bank of Japan’s decision to manage long-term interest rates more flexibly has begun to shake the outlook for short-term interest rates. Swap traders expect the world’s last negative interest rate policy to end in eight months.
This marks a significant change for investors in the Japanese market, which has suffered under negative interest rate policies since early 2016. Investors who have been caught off guard by the BOJ for years are not taking the word of new governor Kazuo Ueda and the policy board. Expectations for the removal of negative interest rates have been brought forward to next July or March, and overnight index swaps suggest short-term policy rates might rise above 0.1% by the end of September 2024.
Markets Bet on an Earlier End to BOJ’s Negative-Rate Policy
Change in BOJ’s short-term policy rate implied by overnight-indexed swaps
Source: Bloomberg
The Bank of Japan made a surprise move last month to give 10-year government bond yields room to rise by as much as 1%, saying it was to make yield curve control (YCC) more flexible. . But controlling the YCC might force it to make purchases that reduce liquidity and distort markets, putting pressure on the BOJ to raise rates as inflation begins to take hold in Japan. For some investors, this seems like a contradiction that undermines policy makers’ claims.
If the negative interest rate policy ends, the sluggish yen exchange rate will be supported, and the financial burden on commercial banks that have to pay interest when depositing surplus funds with the BOJ will be reduced. Yields on long-term government bonds will also rise, increasing the incentive for large Japanese institutional investors to sell assets such as US Treasuries to bring more money home.
“As 10-year government bond yields are unlocked, market participants are gradually turning to short-term rates,” said Eugene Leo, fixed income strategist at DBS Bank in Singapore. It’s a natural progression following YCC is abolished, and it may happen in 2024.”
Governor Ueda said the adjustment on July 28 was not a move toward the end of the YCC, while Deputy Governor Shinichi Uchida said there was “still a long way to go” before raising negative interest rates. But markets are skeptical and clearly see policy moving in that direction, Leo said.
Yields on 10-year bonds rose to 0.655% last week, the highest since 2014. The Bank of Japan was forced to make two temporary purchases of Japanese government bonds to curb a rapid rise in interest rates. Yields on 30-year bonds, the primary investment destination for Japanese life insurers, hit a seven-month high of 1.63% last week.
Investors continue to hedge once morest further rises in 10-year bond yields, with 10-year overnight index swaps at 0.76%. That’s regarding 15 basis points higher than the 10-year bond yield, but below the BOJ’s new 1% cap.
Since the YCC revision, investors have also bought bank stocks in hopes of higher lending margins as interest rates rise. Since July 27, the day before the policy revision, TOPIX has fallen slightly, while the banking industry index has risen by regarding 4%.
Rakuten Bank President Hiroyuki Nagai said in an interview with Bloomberg Television that if the negative interest rate policy is lifted, it will be a big boost to the bank’s earnings. Many of the assets under management are floating rate type, and the ratio is high even among domestic banks, and the impact on interest income will be large when short-term interest rates rise.
“We expect the BOJ to raise its policy rate from minus 0.1% to zero later this year, or early next year,” said Francis Chan, rates strategist at Overseas Chinese Bank in Singapore. Given that, a negative interest rate policy may no longer be appropriate.”
(Adds the third paragraph and adds the interview with the president of Rakuten Bank in the 10th paragraph.)
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