In a week when everyone looks at the transfer of power taking place in America, some important developments for the currency traders happened in Japan. At the start of the trading week, the Bank of Japan (BOJ) hinted that it is ready to end the yield curve control measures.
The BOJ is seen as one of the most proactive central banks in the world. It must be – the Japanese economy suffers from decades-long deflation, and the bank has had a hard time bringing inflation to its 2% target. Part of its efforts to create inflation, the quantitative easing (QE) process exceeded the scale seen in other central bank jurisdictions by far. News by Reuters this week suggested that the BOJ is ready to loosen up its control over yield curve control, thus allowing long term yields to rise.
Why is this important, and what it means for the local currency – the Japanese Yen (JPY)?
Bank of Japan Ready to Help the Domestic Banking Sector
The Japanese banks (and to some extent the European banks too) have long suffered from the easy monetary policy and negative rates in Japan. As such, their profitability declined consistently.
Anyone investing in the Japanese banking sector in the last decade or so has seen their investment declining while the stock market did pretty well. The declining profitability led policy officials in Japan to signal a shift in the long-term rates so as to improve banks’ margins.
And here is the trick – by letting long-term yields rise, the BOJ will deliver a de-facto monetary tightening in a world where everyone is easing. Hence, the move will favor the JPY and JPY investments, especially since the Fed, the ECB, and other major central banks signaled their intentions to keep the rates close to the zero level or below for the foreseeable future.
Therefore, traders should focus on how the BOJ will choose to communicate the shift in policy without triggering a massive appreciation of the JPY. By shifting the policy to an asymmetric yield curve control framework, the BOJ effectively sets the stage for currency appreciation by letting long term yields rise. The JPY is viewed by many as cheap, and by shifting its policy into a slightly hawkish gear, the BOJ signals it is willing to let the currency strengthen.