The Bank of Japan’s (BoJ) first moves to end an era of quantitative easing spurred a rally in the Nikkei 225, now up close to 30% this year. The Yen has been in downtrend for several months, falling over 10% versus the US dollar, and was down again today, but higher domestic rates could stem the decline. On the other hand, a downward move in those assets which benefitted from the Yen carry trade hasn’t happened yet, but it remains a medium-term risk. Oil prices continued to rally as traders balanced declining US crude inventories against an end to ‘growth pessimism’.
TODAY’S MAJOR NEWS
BoJ ends easing policy, will US Treasuries suffer?
What did the BOJ do last week? Technically, not much, but under the surface it could have been a developing Tsunami. The benchmark rate was kept at -0.1 percent and the official target band the central bank sought on the 10-year Japanese Government Bond (JGB) yield was kept in the range 0.5% to -0.5%. The BOJ’s big experiment failed to bring about the promised economic growth by controlling long-term interest, and now leaders are trying to unwind it. Governor Kazuo Ueda were ambiguous about what happens next, suggesting the central bank would allow the JGB rate to climb above 0.5 percent by “a certain degree”. This increase in long term interest rates would make JGBs and the Yen much more attractive.
The BoJ’s baby steps away from quantitative easing lit a fire under Japanese assets. As the only major economy sporting a negative benchmark yield, there is a strong carry trade drive encouraging Japanese investors to invest abroad and foreign entities to borrow in Japan both in the pursuit of higher returns. Compared to higher benchmark interest rates – 5.5% in the US and 4.25 % in the Eurozone –Japan’s baseline is -0.1%, and this has made it the funding source of choice for a range of global investors.
Japan’s policy stance has played an important role in the function of the global markets, providing trillions of dollars that is used to buy US Treasuries, foreign real estate investments, emerging and developed equity markets. The implications are massive and unwinding these trades could be painful. Japanese investors are the largest holders of US government debt at $1.13 trillion, while China comes in second at $0.87 trillion.
The fear is that Japanese investors will rotate out of US Treasuries as Japanese rates start to recover, resulting in the need for US yields to rise to find new buyers. Finding new buyers of US Treasuries could become more difficult. Wall Street has been focused on when the Fed may pivot on its interest rate policy, but that doesn’t necessarily mean that longer-term rates will be going down anytime soon.
China’s growth crisis deepens
China’s economic data continues to reflect problems, with factory activity contracting in July for the fourth consecutive month. The non-manufacturing sector continues to see modest growth, but at a slowing pace, with shrinking exports to the West decouples from China Analysts continue to expect more stimulus, but China’s economic toolbox has very limited options at this point.
TODAY’S MAJOR MARKETS
- Stocks were becalmed in morning trade, with the Nasdaq, Russell 2000, and S&P 500 all pretty much unchanged
- Global markets were also flat, with the FTSE 100 and DAX unchanged – while the Nikkei 225 was up 1.3% on news out of the Bank of Japan
- The VIX, Wall Street’s fear index, rose to 13.7
Currencies and Bonds
- The dollar index rose 0.2% against a basket of currencies, at 101.8
- Sterling and Euro dollar cross rates were pretty much unchanged, while the Yen fell 0.8%
- Bonds rallied, with yields on 2- and 10-year Treasuries falling back to 4.85% and 3.96% respectively
- Crude oil prices rallied again, up 1.6% to $81.9 per barrel
- Gold rose 0.3% to $2,005 per ounce, while silver rose 1.6% at $24.9 per ounce
- Grain and oilseed markets were again lower on end of month profit-taking
Analysis by Arlan Suderman, Chief Commodities Economist: Arlan.Suderman@StoneX.com
Market outlook by Paul Walton, Financial Writer: Paul.Walton@StoneX.com