BOJ Rate Hike Boosts Stocks and Futures

The MSCI Asia Pacific Index saw a rise, thanks to the outperformance of Japanese equities. The Nikkei 225 index experienced the most significant increase in a month as speculations mounted that the Bank of Japan would put an end to its negative-rate policy on Tuesday. The yen was weaker against the dollar, contributing to the rise of Japanese stocks.

Charu Chanana, a strategist at Saxo Capital Markets based in Singapore, noted that Japanese stocks are on the rise due to the weakening of the yen and the expectation that the currency won’t strengthen even if the central bank hikes. According to Chanana, the focus is much more on Nvidia and the Fed this week, although the BOJ is all priced in.

Equities in China rallied, thanks to surprisingly strong economic numbers that provided further evidence of more traction for the world’s second-largest economy. However, the data is unlikely to push the yuan out of its recent tight range as the currency is torn between China’s central bank and the upcoming Federal Reserve policy meeting.

Commonwealth Bank of Australia suggests that “A potentially hawkish FOMC meeting can place upward pressure on dollar-offshore yuan” this week, but that “will likely be capped by the People’s Bank of China’s continued onshore yuan support at the daily fix.”

The direction of global stocks for the next quarter may depend on the outcome of the Fed’s policy meeting on Wednesday. Before the blackout period, Chairman Jerome Powell indicated the central bank was close to having the confidence to cut, while others debated how deep or shallow those declines would be.

BOJ’s Impact on Japan’s Foreign Investments

“Japan’s investors continue to seek higher returns by investing abroad, undeterred by the Bank of Japan’s efforts to stimulAnalysts say that despite the Bank of Japan preparing for a significant change in monetary policy, much more will be needed to materially shift the roughly $3 trillion of yen that Japanese investors have invested in global bond markets and yen trades.

Japanese investors have invested trillions of yen overseas to earn better returns than the near-zero returns available at home under the BOJ’s decades-long effort to end deflation.

The BOJ may change that policy as soon as this week. Rising wages and other business activity suggest stagnation is over, which means there is little need for the BOJ to continue to keep short-term rates negative.

Anticipation of better growth has drawn foreign money into Japanese stocks and driven yen bond yields higher. It has also put the spotlight on the $2.4 trillion of foreign debt held collectively by Japan’s life insurance companies, pension funds, banks, and trust firms and how much of those investment flows will return home.

However, these holdings earn yen investors upwards of 5%, so investors may barely react if the BOJ raises its rates by 10 or 20 basis points, according to analysts.

“I honestly don’t think it will have a big impact on flows,” says Alex Etra, a senior strategist at analytics firm Exante Data.

As per the Ministry of Finance, Japan’s foreign portfolio investments amounted to ¥628.45tn ($4.2tn) at the end of December. Out of this, half of the investments were in interest rate-sensitive debt assets and most of it was long-term.

The BOJ embarked on its quantitative and qualitative easing (QQE) in May 2013, during which time Japanese investment in foreign debt was about 89 trillion yen, nearly 60% of which belonged to pension funds, including the giant Government Pension Investment Fund or GPIF.

Etra says the country’s pension funds routinely do not hedge their overseas bond investments for currency risk, and their returns on foreign bonds are attractive, especially when translated into yen.

However, Gareth Berry, a currency, and rates strategist at Macquarie Bank, says: “I’m not a huge believer of that repatriation story. If you look at the numbers down the last 20 years, there was very little repatriation even during the GFC.”

Unlike pension funds, Japan’s big banks and life insurance firms tend to hedge their foreign bond holdings to mitigate any risk to their deposits and other yen liabilities. Flows data shows this class of investors, which includes Japan Post Bank and cooperative bank, the Norinchukin Bank, has gradually reduced foreign debt holdings since 2022.

Nomura strategist Jin Moteki says investors such as insurance firms will repatriate foreign investments only when there is sufficient yield at home in Japanese government bonds (JGBs). He estimates serious repatriation will occur only when 20-year JGB yields touch 2%, which implies a roughly 50 basis points rise in longer yields. Nomura expects the BOJ to raise the overnight rate to 0.25% by October.

“In our view, the potential repatriation that might be triggered by the end of YCC is likely to be around 45 trillion yen, at a maximum. We also expect Japanese life insurance companies to become potential main players of the repatriation,” Moteki said.

Moreover, if short-term yen rates rise just as the Fed starts cutting its rates, hedging costs would fall, making FX-hedged investments in U.S. Treasuries more appealing.

Japan Post Bank, Norinchukin, and GPIF did not immediately reply to Reuters’ requests for comments on their investment plans.

The implications of the BOJ exiting negative rates on the murkier world of FX carry trades depend heavily on the signals the BOJ sends on the trajectory for rates, rather than just the first hike.

Investors have been using the yen as the preferred currency for funding trades for many years. In these trades, investors borrow yen at zero cost and exchange it for dollars, which have a higher yield. These trades are short-term and generate significant profits. However, they are also highly sensitive to even small fluctuations in interest and exchange rates.

A 3-month dollar-yen carry trade earned 7% annualized in December but now earns only 5% because both the yen and Japanese yields have risen.

There is no easy way to estimate the number of such trades. Japan’s overall short-term lending to foreigners is cumulatively around $500 billion and could be a rough gauge of outstanding carry trades.

The ‘carry’ in these trades could shrink quickly if the market started pricing in higher short- and medium-term yields.

James Malcolm, a currency strategist at UBS in London, notes that a change of about 10 basis points in the interest rate gap between dollars and yen has roughly led to a 1% move in the dollar-yen rate in the past two to three years.

“Now, when you have a large carry trade built up, the risk is that modest changes cause capitulation and FX moves much further by generating its own dynamic.”

Nikkei 225 Long (Buy)
Enter At: 39946.92
T.P_1: 40437.10
T.P_2: 40947.17
T.P_3: 41395.44
T.P_4: 41817.53
T.P_5: 42292.38
T.P_6: 42925.52
T.P_7: 43505.90
S.L: 37323.39