Yen Plunges as BOJ Affirms YCC

March 28, 2022

Win Thin

The selloff in global bond markets continues; this is a big data week for the U.S. and yet the readings are unlikely to have much impact on markets or policy; U.S. rates continue to move in the dollar’s favor; Treasury has a heavy schedule of coupon issuance this week
Gilts are taking part in the global bond rout as BOE tightening expectations have picked up
BOJ underscored its dovishness by defending its Yield Curve Control target; the yen weakened sharply as a result; officials gave the first inkling of concern about yen weakness

The dollar rally continues as the new week begins. DXY is back above 99 for the first time since March 16 and traded near 99.31. This month’s cycle high near 99.418 should eventually be tested and after that, our next target is the May 25 2020 high near 99.975. It’s all about the yen today as the BOJ underscored its ultra-dovish stance (see below). USD/JPY traded above 125 for the first time since August 2015 and is on track to test the June 2015 high near 125.85. After that, there are no significant chart points until the January 2002 high near 135.15. The euro remains heavy just below $1.10 and we still expect an eventual test of this month’s cycle low near $1.08. Sterling is trading heavy near $1.3140 after being unable to sustain a move above $1.32 last week. We look for an eventual test of this month’s new cycle low near $1.30 and then the November 2020 low near $1.2855. Between the likely return of risk-off impulses and the even more hawkish Fed outlook for tightening, we believe the dollar uptrend remains intact.

AMERICAS

The selloff in global bond markets continues. The long end is being pressured by heightened inflation fears, while the short end is being pressured by expected central bank policy responses. Equity markets are unfazed and continue to rally. What this suggests to us is that the equity markets have faith in the major central banks that a soft landing can be achieved. While that is also our base case, we acknowledge that the risks of a hard landing are not insignificant. A portion of the U.S. yield curve has inverted and this bears close watch.

This is a big data week for the U.S. and yet the readings are unlikely to have much impact on markets or policy. Barring a complete collapse in the economy, the Fed is dead set on removing accommodation quickly and aggressively. 50 bp hikes for May 4 and June 15 are both about 75% priced in. Looking ahead, the swaps market sees the policy rate at 2.75% over the next 12 months and peaking near 3.0% over the following 12 months. Despite the steady move higher in expectations, we believe the Fed Funds rate may have to move above 3% in order to properly cool inflation. February advance goods trade (-$106.3 bln expected), wholesale (1.2% m/m expected) and retail inventories (1.4% m/m expected), and March Dallas Fed survey (11.0 expected) will be reported today.

U.S. rates continue to move in the dollar’s favor. The 2-year yield traded at 2.41% today, the highest since May 2019. Charts point to an eventual test of the November 2018 high near 2.97%. Similarly, the 10-year yield traded at 2.55% today, also the highest since May 2019. Here, charts point to an eventual test of the October 2018 high near 3.26%. The 2-year differentials with Germany, Japan, and the U.K. continue to rise to multi-year highs and point to further weakness in the euro, yen, and sterling vs. the dollar.

Treasury has a heavy schedule of coupon issuance this week. $50 bln of 2-year and $51 bln of 5-year notes will be sold today, followed by $47 bln of 7-year notes tomorrow. With yields at multi-year highs, will investors snap up new issuance or wait for yields to move even higher first? Keep an eye on the demand metrics. Bid/cover ratio at the last 2-year auction was 2.64 and indirect bidders took 65.6%, while the bid/cover ratio at the last 5-year auction was 2.49 and indirect bidders took 67.8%.

EUROPE/MIDDLE EAST/AFRICA

Gilts are taking part in the global bond rout as BOE tightening expectations have picked. The 10-year gilt yield has risen to 1.75%, the highest since January 2016. The November 2015 high near 2.09% is the next target, followed by the June 2015 high near 2.21%. WIRP suggests a hike at the next meeting May 5 is fully priced in, with nearly 50% odds of a 50 bp move then. Swaps market now sees the policy rate peaking near 2.5% over the next 12 months, up from 2.0% at the start of last week. Bailey speaks today, while Chancellor Sunak testifies.

ASIA

The Bank of Japan underscored its dovishness by defending its Yield Curve Control target. For the first time ever, it offered to buy unlimited 10-year JGBs for three straight days at the upper limit of the YCC trading band at 0.25%. This was the BOJ’s first operation since February 14, which in turn was the first such operation since 2018. The BOJ said that the three-day operation was meant to support YCC and that it could change the schedule as well as the amounts depending on how markets responded. As a result of YCC, JGBs have not fully participated in the global bond market selloff.

The yen weakened sharply as a result. Given that we have long expected the BOJ to maintain its ultra-dovish policy well into FY24, the reaction in the FX market seems to be a bit of an overreaction. USD/JPY traded above 125 for the first time since August 2015 and is on track to test the June 2015 high near 125.85. After that, there are no significant chart points until the January 2002 high near 135.15. The weaker yen helps boost exports but it also feeds into higher inflation as imports become more expensive.

Officials gave the first inkling of concern about yen weakness. Chief Cabinet Secretary Matsuno said policymakers are paying close attention to FX market trends, including the recent weakness in the yen. Matsuno said that rapid FX moves are not desirable but would not comment on any particular levels. The first step in FX intervention is typically verbal and we are likely still far away from actual market intervention. If memory serves, the last time the BOJ intervened to support the yen was back in 1998. Over the course of a year, the yen weakened more than 30%. Compare this to the current bout of yen weakness that has seen losses of a little more than 20% since early 2021. The fundamental story argues for further yen weakness as the central bank divergence story remains the strongest driver for the USD/JPY pair.

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