Market Views: Is Japan on the brink of ending negative rates?

The world’s last negative-rate market seems close to making an exit. When and how will that happen? AsianInvestor asked investment experts for their take.
Market Views: Is Japan on the brink of ending negative rates?

After maintaining inflation well above its 2% target for over a year, the Bank of Japan (BoJ) is leaning towards a hawkish stance and expected to abandon the country's negative interest rate policy (NIRP).

This shift comes in anticipation of significant wage increases in the spring.

The BoJ may soon announce a new policy decision following its March meeting next week, with the conclusion of the yearly wage negotiation between labour unions and enterprises on March 15 being a deciding factor, according to media reports citing sources familiar with the matter. 

If Japan raises interest rates, it will end the world's negative interest rates era that started in the 2010s.

There are expectations that the BoJ will also end the yield curve control, or YCC, which has been keeping 10-year Japanese government bond (JGB) yield at around 0%.

In financial markets, the benchmark Nikkei 225 index declined modestly after reaching a 30-year high last week. 

The Japanese yen (JPY) has been gaining strength against the dollar throughout March. Additionally, the yields on 10-year JGB have risen to their highest level in three months, yet they remain below the 1% mark.

We asked experts when the rate hike will happen, how monetary policy will change, and what the impact will be on financial markets.

The following responses have been edited for clarity and brevity.

Naka Matsuzawa, chief strategist, market strategy research
Nomura Securities

Naka Matsuzawa

I believe the BoJ will make a comprehensive change to its policy framework at its March meeting (on March 18-19).

The package includes 1) raising policy rate target from -0.10% to a range target of 0.0-0.1%; 2) removing yield curve control, while scrapping the 10-year yield target; 3) pausing ETF purchase; 4) holding off on the commitment to keep increasing monetary base; and 5) introducing a new quantitative target (starting with a monthly JGB purchase of 6 trillion yen).

The 4) and 5) together imply the BoJ will start quantitative tightening soon.

Immediate reactions of the markets should be muted as the BoJ communicated well with the market about what it will do in the next step of normalisation. Having said that, the market is yet to digest how fast the BoJ will cut its JGB purchases and that could lead to higher yen, higher JGB yields and lower share prices.

There will also be a shift in preference towards stock sectors from exporters to domestic demand-driven ones.

Kensuke Niihara, chief investment officer, Japan
State Street Global Advisors

Kensuke Niihara

The BoJ has been constructively guiding markets on their impending policy change, which we have been expecting to begin in April.

However, Rengo (Japanese Trade Union Confederation) demanded a 5.85% average shunto (annual wage negotiations) wage hike this year (a 30-year high), which was honored by large corporations.

Taken together with the BoJ’s assessment of firm underlying inflation, these developments have raised the chances of a policy move in March significantly. We expect the policy rate to have moved out of negative territory to 0.10% by the end of this year.

Our evaluation shows that the JPY is deeply undervalued, and we are bullish on JPY in the long term. Possible divergence in policy direction between the Federal Reserve and the BoJ is supportive of a stronger JPY.

However, we believe that the BoJ will maintain an easy monetary policy after the exit from negative interest rate policy (NIRP), therefore we expect the impact on the market including JPY will be limited.

This moderate policy stance of the BoJ and expectation of soft-landing for global economy would support Japanese equity market where we see a mixture of positive factors like macro/inflation backdrop to support corporate profitability, governance reform to increase efficient use of capital and better demand and supply supported by the Nippon Individual Savings Account (NISA, a tax-free stock investment programme).

If the Fed moves into a steady cutting cycle resulting in more than 100-150 bps or Japanese wage increase and economic growth is strong enough to support multiple hikes by the BoJ, JPY could appreciate meaningfully.

Naomi Fink, global strategist and managing director
Nikko Asset Management

Naomi Fink

The market has almost fully priced in an imminent hike. However, as BoJ officials clarified, one should not assume ending NIRP will be followed by a series of rate hikes. 

So far, information on wage increases has been positive, with signals of wage inflation, decelerating inflation, but without real wage growth yet.

I anticipate BoJ would like to see real wage growth before it follows any NIRP/YCC adjustment with a rate hike. Consensus is another hike in the second half.

One big implication for short-term bond markets from exiting NIRP is Japan may regain a functional money market, which I see as a positive. Meanwhile, the implication for bonds would be mild pressure, though BoJ's caution may be sufficient to prevent a significant decline.

For equities, positive signals of corporate profits, governance, and composition of capital expenditure bode well.

If we see, as we anticipate, real wage growth, later this year, we look for households redirecting cash toward investment, including Japanese stock. 

Foreign investors have been accumulating Japanese stock, but Japanese households' increased NISA participation has been directed toward foreign stock.

The relative policy direction (Fed tightening and BoJ staying put) helped the dollar rally significantly against the yen; however, with BoJ’s expected hike and markets expecting Fed cuts, yen strength may have run its course. 

With BoJ’s caution in removing stimulus and Fed’s reluctance to ease while economic conditions outperform expectations, we may see little impetus for yen strength. Dollar-yen may continue range-bound until interest rate differentials are clearer.

Aadish Kumar, international economist
T. Rowe Price

Aadish Kumar

A policy framework revamp is likely in April and the updated April inflation forecasts will provide an opportunity for the BoJ to communicate greater confidence in achieving its target.

I anticipate a policy rate increase to 0% and the removal of references to the yield curve control (YCC) target from the statement. To maintain some control over long-term Japanese government bond (JGB) yields, the BoJ is likely to retain the 1.0% reference rate for the 10-year JGB.

BoJ is also likely to maintain flexibility and adjust bond purchases based on yield volatility and speed. Additionally, I expect the BoJ to gradually reduce bond purchases in the coming months and to drop its forward guidance to increase policy flexibility.

Weak economic activity and the possibility of downside surprises in inflation support my base case of no further rate hikes this year following the anticipated exit from the NIRP.

Despite structural wage pressures, growth is weak. The tailwinds of weak yen, Covid reopening effects, and an increase in tourism are fading. 

Comments from the Ministry of Finance Japan suggest a lower level of concern on JPY compared to September 2022 as volatility remains normal and there is no large currency misalignment from fundamental factors.

The USD/JPY exchange rate matters most when assessing intervention risk. Public pressure is currently at low levels as inflation is easing. 

More broadly, the sentiment on the JPY was negative both in the short and long term as the BoJ will move gradually and Japan continues to face structural headwinds (weak growth and capital outflows as locals increase overseas investments).

Aaron Rock, head of nominal rates

Aaron Rock

We think the BoJ are likely to abandon NIRP and raise policy rate by 0.1% to zero at their April meeting. There is a considerable risk they act sooner at the March policy meeting, but on balance, we expect they will wait until April to have as much information on the outcome of the Spring wage negotiations as possible.

By this time, they will also have the Q1 Tankan Survey (quarterly BoJ survey) data and the updated ‘Regional Economic Report’ which will provide valuable insight into household behaviour and corporate’s ability to pass on input price costs.

With respect to YCC and asset purchases, we suspect the BoJ will want to delay completely abandoning this policy tool until after they decide to exit negative rates.

Although the policy tool will need to evolve to remain credible, retaining some form of flexibility in asset purchases will be viewed as prudent given the likelihood of increased volatility in the JGB market.

Looking beyond the first hike we expect the BoJ will stress that policy will remain accommodative, nonetheless, we see them being forced into a further hike in Q3 to bring policy rate to 0.25%.

For the yen, we expect the tightening of monetary policy to herald a period of strength, with appreciation somewhere in the region of 8-10% for the currency versus other majors over the next calendar year.

Embedded in our view is the expectation that we will see the Fed, European Central Bank and Bank of England all begin to cut policy rates in June, so rate differentials will shift considerably in favour of the JPY.

Although a stronger currency may deter some of the overseas investor bases who have driven the recent bull market for the Japanese stocks, for JGBs we expect the long end of the curve will remain well supported by domestic investors, with the anticipated change in hedging costs favouring repatriation from holdings in semi-core and peripheral Eurozone government bonds.

Carol Lye, portfolio manager & senior research analyst
Brandywine Global

Carol Lye

According to the latest number from the Shunto wage negotiations, the numbers are above 4%, which is meeting the BoJ target and much higher than last year’s. A lot of the large companies in Japan are giving in to the wage negotiations.

Therefore, there is a very high chance that the wage hikes would prompt the BoJ to end its negative interest rate policy next week or in April.

In the BoJ meeting next week, we are looking out for guidance on future policy rate hikes. We need to see a vicious cycle of higher inflation working into higher consumption to attain sustainable inflation.

At current levels where JGBs are yielding below 1% and with a wide interest rate differential to US Treasuries, we do not see an investment opportunity in JGBs.

In terms of the currency, we remain positive on the Japanese yen. It appears the yen is being driven more by what is happening on the US side rather than simply what is happening on the Japanese side.

We continue to see inflation coming off in the US, the growth differential this year will be a bit more in favour of a weaker dollar going forward. This would be a tailwind in relation to the yen’s appreciation. The investment implications in the medium term continue to point toward a stronger yen.

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