The Reserve Bank of Australia delivered the 25 bp rate cut that was widely expected earlier this week. Today, the Bank of England provided a new framework for its forward guidance, linking monetary policy to unemployment formally for the first time, and implying that barring a change in circumstances (inflation expectations and financial stability) rates could remain low through Q3 2016.
The BOJ's two-day meeting concludes tomorrow. Although surveys show not expectations for new initiatives, a Bloomberg poll found that the vast majority of those queried expect the BOJ to increase the amount of its asset purchases in the coming months. Five see the action coming in the fourth quarter this year, 15 in the first half 2014, and five in the second half of 2014 or later. The BOJ has revised up its assessment of the economy for seven consecutive months, but recent data has been disappointing. Growth next year is anticipated to be slow, partly under the weight of the controversial retail sales tax that is to be implemented in April 2014 and another hike in October 2015.
The BOJ has successfully managed to stabilize the JGB (Japanese government bond) market after a rise in both yields and volatility followed the announcement of very aggressive asset purchase program about four months ago. The BOJ is buying JPY7 trillion (~$72 billion) a month of securities, mostly JGBs.
At the end of March, the 10-year JGB was yielding around 0.55%. After QE was announced, yields spiked higher and reached almost 1% by May 23. Changing its tactical implementation of QE (more frequent though smaller purchases) has helped stabilize the bond market. the 10-year yield has been largely confined to about 10 bp (0.80%-0.90%), but has now broken out to the downside. Today's 0.75% yield is the lowest since mid-May, meaning it has retraced a little more than a third of rise. The 4% decline in the Nikkei earlier today may have helped underpin the JGBs.
The U.S.-Japan 10-year interest rate differential is near 186 bp, just off the two-year high set at the start of the month near 190 bp. However, the dollar has found little succor in the wider premium, as the dollar is trading at six-week lows. The inability of the dollar to rise above JPY100 at the end of last week had sparked selling this week.
Since the Japanese election was called last November, the dollar-yen rate seems more sensitive to the equity market than interest rate differentials. Counterintuitively, Japanese investors have been selling foreign bonds until recently, while foreign investors have been generally buyers of Japanese equities. Among the most popular U.S.-based ETFs this year has been Japanese equity funds, including one that hedges out the currency risk.
Coming into today's session, the dollar had already retreated about 2% from the pre-weekend high near JPY100. The follow-through selling today, on the back of the 4% drop in the Nikkei, pushed the dollar to its lowest levels since June 20 and completed a retracement objective of the mid-June through early July rally (61.8% of the move from JPY93.80 to JPY101.50 comes in near JPY96.75). The next level of support is found near JPY96. A trend line drawn off the late February lows and the mid-June lows comes in near JPY95.20. Those mid-June lows were recorded near JPY93.80.