A question haunts Tokyo financial markets: when will the Bank of Japan (BoJ) exit negative interest rates? The country’s largest bank expects the move to occur within two weeks and is positioning itself accordingly. Mitsubishi UFJ Financial Group Inc.’s view is much more definitive than that of the swaps (derivatives) market, which estimates the chances of BoJ Governor Kazuo Ueda changing monetary policy this month at just 50%. When it changes course, it will have big implications for both the government bond market, valued at 1,096 trillion yen (7 trillion euros), and for the Japanese country’s national currency.
“I think it is necessary to end the negative interest rate in March, not April,” explains Hiroyuki Seki, head of global markets business at MUFG, in an interview with Bloomberg. The Japanese Strategist’s Reason Is That Boxwood Is Likely To Make An Additional Increase To Bring The Rate To 0.25% By October “For Policy” After INCREASE RATES AT ITS NEXT Meeting On March 19 For The First Time since 2007. The BOJ “needs to lock in the next rate hike well in advance,” he said.
Seki noted that his outlook on the BoJ’s action is based on cues conveyed by public statements by central bank officials, as well as political and other developments this year, which will likely dictate monetary policy options. Overnight index swap traders see the chances of a March move at around 53%, rising to an 80% chance of a rally for April as of late last Wednesday. At the end of last month, the probability stood at 26%.
Seki said there will be “structural changes” in the Japanese government bond market once the BOJ ends negative rates and starts paying 0.1% interest rates on reserves. This will likely trigger a drop in demand for sovereign yen bonds (JGB), driving down their prices and raising their yields. The yield on Japan’s benchmark 10-year government debt rose 1.5 basis points to 0.71% on Wednesday. MUFG is holding bearish positions in bonds through mutual funds and index swaps overnight in anticipation of the BOJ move.
After short- and medium-term rates start to rise, MUFG will build up swap receiving positions, as overnight indexed swaps are undervalued relative to bonds, Seki explained. The strategist added that the bank plans to do so once 10-year indexed swaps reach at least 1.1% or 5-year indexed swaps at least 0.6%.
It also plans to start investing in bonds “in earnest” if the securities’ overvaluation corrects itself, with its yields converging toward the corresponding swap rates. Yields on 10-year bonds will likely trend toward 1.0% and beyond, and 5-year yields toward 0.6% or higher, according to Seki. MUFG experts expect the BOJ to do more than just raise rates. At the introduction of the negative interest policy in 2016, the BoJ adopted the three-tier system, in which interest rates of 0.1%, 0% and -0.1% are applied to parked bank balances as reserves in the central bank.
Seki noted that the BOJ is likely to eliminate the system along with the negative interest rate and that a 0.1% interest rate will be applied to all money in the central bank’s reserves. And the BOJ’s policy target is also likely to shift to unsecured overnight spot interest rates, which are expected to rise to a range of 0-0.1% from the current -0.1-0%. Seki expects the BOJ to maintain its yield curve control for a while to curb excessive volatility after the policy change. “I don’t think the ceiling benchmark will be removed. It will likely be maintained with more flexibility.”
