Few central banks have been more transparent about their plans or predictable in their decisions than the Bank of Japan. Their tactics have defined the easy money era, and central bankers there have been clear about both what would cause them to tighten policy while the rest of the market focused on how far off those benchmarks actually seemed.
Backdrop for the Bank of Japan Meeting This Week
This openness explains why initial surprise turned to mild intrigue in the days since January 9th when the Bank of Japan (BOJ) communicated they reduced their purchases of Japanese Government Bonds with 10 to 25 years until maturity, as well as for those with 25 to 40 years remaining, by 10 billion yen ($89.7 million) each. It was the first time in more than a year that the central bank reduced the purchasing operation for bonds with 10 to 25 years left to maturity. This reduction was termed "stealth tapering" in Tokyo as market watchers looked for any sign that a strenghtening economy in Japan would lead to a tightening of policy and that the Japanese era of loose money was coming to an end.
As a result, the Yen strengthened versus the Dollar in global FX markets.
At the same time the Yen received this news which is ultimately constructive to the price of the Yen, the Dollar has continued a broad based slide. In the chart below, the candlesticks represent USDJPY, and the blue line is the Dollar index (DXY).
Key Bank of Japan Themes to Watch:
1.No changes expected – Regarding formal monetary policy, it is a safe bet that the BOJ will not take any meaningful steps towards a new direction in policy. This has been the tune the bank has sung for some time, but this was in doubt as recently as last week for some Yen watchers in global markets. We see the changes in bond purchasing behavior as a normal evolution of process which triggered an unwarranted overreaction. There is a very low probability for any structural changes in BOJ policy.
2.Press Conference – Always an unpredictable wildcard on the world financial stage, Governor Kuroda is genuinely capable of saying anything relative to his normally tight-lipped central banking peers. A key watchword for his remarks following the decision will be “normalization”. While we expect no meaningful hawkish tilt from the bank or Kuroda-san, if he does overtly discuss a normalization of policy, this would be both a profound shock and market mover for the Yen in global FX exchanges.
3.Kuroda’s second term – Kuroda is increasingly looking like a favorite for a second term at the help of the Bank of Japan. Discussion of his future transcends near-term considerations and forces a closer examination of the long-term arc of Japanese monetary policy. With Kuroda being seen increasingly as a favorite for a second term, this should allow for a long-term continuation of a weaker Yen. Any candidate other than Kuroda, or even a heating up of speculation that Kuroda’s position might not be as strong as once thought, would certainly trigger a strengthening move in the Yen.
4.Dollar weakness– While the Yen will be front and center in this week's early frame due to the BOJ meeting, lurking behind the scenes as an omnipresent influence is the US Dollar. Multi-year weakness in the dollar weighs on the Yen and will limit any potential volatility from a further weakening of the Yen.
Our baseline outlook is for a relatively uneventful meeting following a brief period of heightened speculation and conjecture. The bank is generally pleased with the economic progress, although the pace has left something to be desired, as the stock market, production, and employment markets are all sound and performing well.
Inflation has ticked moderately up. And while it is not close to the BOJ's target nor enough inflation to motivate a change towards a normalization in policy, it is progress that can be used as justification for an extension of the current path.
An extension of Dollar weakness, partially attributable to political controversy in Washington D.C., will keep the USDJPY pair moving moderately lower through the week. A close below 110.30 is well within reach, and the preponderance of probability is for a move lower to the 110.00 level.
The risk to this outlook would result from more hawkish language than expected from Kuroda, or a spontaneous strengthening of the US Dollar, neither of which is likely.