Yen calls out the risks surrounding the Bank of Japan

I am shocked at the lack of commentary about the Bank of Japan meeting next week and how that affects the markets.

The Bank of Japan’s decision came out on Wednesday (late Tuesday US time) and the forex market is screaming that the risks around it are rising.

There have been persistent reports that the BoJ raised its inflation forecast at the meeting, and Yomiuri announced yesterday that the BoJ will look into the side effects of its easing at the meeting. Since then, the USD/JPY pair has lost nearly 400 pips and dropped to its lowest level since May.

USDJPY daily

I also think that the risk of Japanese investors becoming too aggressive in Japanese bonds is what drives supply into Treasuries. This sent a false cautionary signal to stocks and reverberated elsewhere.

So what if the Bank of Japan changes its policy?

In December, the Bank of Japan surprised the market by moving the 10-year yield curve control limit to 0.50% from 0.25%. This led to a 600 pips drop in one day for USD/JPY despite the Bank of Japan insisting it was just a technical change.

The market is definitely feeling the change here, but no idea what that will be. Just another 25bps in YCC could trigger a USD/JPY rebound bounce at this point, but you can’t rule out the BoJ giving it away completely. Moreover, the prediction of a return to the inflation target in 2024 also paves the way for policy normalization, which according to the Bank of Japan is likely to be a policy rate of 1.00%.

But due to the massive intervention of the Bank of Japan in the bond market, the path to JGB free trade again is very risky and can lead to huge paper losses. I could write a scenario where it could be bullish or bearish for US Treasuries because there could be a safe haven supply (like there is now) or money exploding.

In general, volatility is bad news and will hurt stocks and affect global growth sentiment.

For now, my playbook is to reduce exposure and keep a close eye on Japan.

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