RBA Pivots, BOJ Delivers, USD Powers Forward

• The RBA leaves the cash rate target at 4.35% (no surprise) but unexpectedly drops its tightening bias. AUD plunges.

• BOJ raises the policy rate from -0.10% to a target range of 0 to 0.10% and scraps yield curve control. JPY underperforms across the board.

• Canada’s February CPI print risk showing that progress on inflation may be stalling. CAD can edge higher against other commodity-sensitive currencies.

The RBA kept the cash rate target at 4.35% (no surprise) but unexpectedly dropped its tightening bias. The RBA tweaked its policy guidance from warning that “a further increase in interest rates cannot be ruled out” to “the Board is not ruling anything in or out”. Accordingly, the tone of the RBA statement was more cautious noting that wages growth “appears to have peaked” and “household consumption growth remains particularly weak amid high inflation and the rise in interest rates”.

RBA cash rate futures shifted sharply at the short end. Futures now imply a 35% probability of a first 25bps cut in May and a total of 50bps cuts in 2024. Before today’s meeting outcome, RBA cash rate futures were pricing a small 10% probability of a rate hike in May and 80% odds of 50bps of cuts this year.

AUD/USD plunged by as much as 0.80% to lows around 0.6515 and Australian bonds rallied across the curve (mostly at the 3 and 5-year terms). AUD/USD can break below its February low (0.6443) if, as we expect, the Fed turns less dovish tomorrow.

The BOJ raised the policy rate from -0.10% to a target range of 0 to 0.10% and ended yield curve control. According to the BOJ, the price stability target of 2% would be achieved in a sustainable and stable manner by 2025.

Specifically, the BOJ will no longer target 10-year JGB yields of “around” 0% with 1% as an upper bound reference. Instead, the BOJ will continue its JGB purchases “with broadly the same amount as before”. In case of a rapid rise in long-term interest rate it will make nimble responses”. The monetary policy implications are minimal because the BOJ has been slowing JGB purchases for the past year and 10-year JGB yields have been contained well under 1% on average.

Moreover, the BOJ will discontinue purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). This is not surprising considering the BOJ has not bought ETF/J-REITs since October 2023 and Japan’s stock market rallied recently to a 34-year high. The monetary policy implications are minimal because ETFs and J-REITs account for only 5% of the BOJ’s balance sheet.

Finally, the BOJ will gradually reduce purchases of Commercial Paper (CP) and corporate bonds and will discontinue the purchases in about one year. The monetary policy implications are minimal because CP and corporate bonds account for just 1% of the BOJ’s balance sheet.

USD/JPY surged by roughly 0.80% above 150.00 and 10-year JGB yields dipped 2bps to 0.72%. The market reaction suggests a rate hike was better telegraphed than money market pricing implied (50-50 odds of a hike).

We are sticking to our bearish JPY view because Japan’s improving inflation backdrop and soft economic activity suggest the BOJ is unlikely to normalise the policy rate by more than is currently priced-in over the next 12 months (+20bps). Indeed, the bar for an aggressive BOJ tightening cycle is high. First, the BOJ “anticipates that accommodative financial conditions will be maintained for the time being”. Second, the decision to end the negative policy rate was not unanimous. Two BOJ policymakers preferred to continue with the negative interest rate policy.

US February housing starts and building permits are the domestic highlights (12:30pm London). In February, building permits and housing starts are projected to rise 0.5% and 8.2% m/m, respectively, consistent with a further improvement in housing market activity. The US Treasury also releases the January 2023 Treasury International Capital (TIC) data later today (8:00pm London). The TIC data is not a market mover, but it’s a good indicator of foreign appetite for US long-term securities (Treasury, Gov’t agency, corporate bonds & equities). Cumulative net foreign purchases of US long-term securities are near historical high levels.

EUR will likely ignore the March Eurozone ZEW expectations of economic growth survey and the Q4 labour costs report (both at 10:00am London). Labour costs are expected to ease in Q4 2023 from 5.3% y/y the previous quarter confirming the decline in the already released Q4 compensation of employee print to 4.6% y/y. The ECB is waiting to have more data on the evolution of wages before cutting interest rates. The ECB’s timelier indicator of negotiated wage rate for Q1 is scheduled for release on 23 May, two weeks before the 6 June ECB rate-setting meeting. Interest rate futures are pricing 80% odds of a 25bps ECB rate cut by June.

USD/CAD is up on broad USD strength. CAD can edge higher today against other commodity sensitive currencies as Canada’s February CPI print (12:30pm London) risk showing that progress on inflation may be stalling. Annual headline CPI inflation is expected to rebound to 3.1% in February (from 2.9% in January) driven by higher shelter services prices. The BOC projects inflation to average 3.2% y/y in Q1. Annual core CPI inflation rates are also expected to remain sticky above 3%. Bottom line: above target inflation means the BOC can be patient before loosening policy. Canada’s OIS curve implies a first 25bps policy rate cut in July.