BOJ’s commitment to be tested again - Nomura

Analysts at Nomura explained that the USD/JPY appreciation momentum remains strong, even after breaking 115 last Friday. 

Key Quotes:

"Higher oil prices and positive risk sentiment are supporting the appreciation trend today. 

The yield differential between the US and Japan keeps widening too, as the yield curve control puts downside pressures on Japanese yields amid the global reflation trend. 

While 10yr UST yields broke 2.50%, 10yr JGB yields also continue to rise, approaching 0.10% gradually. The BOJ’s commitment to its yield curve control looks likely to be tested again (see “BOJ takes steps to control yield curve”, 17 November 2016). In fact, Reuters reported today that the BOJ is going to discuss upgrading its economic assessment at the meeting next week (19-20 January). 

The Bank is likely to have a more positive view on the external economy, while the recent financial market reactions are expected to have a positive impact on consumer sentiment. 

Nonetheless, the BOJ is likely to maintain its strong commitment to the 10yr yield target for now, to ensure a low real interest rate environment. The BOJ has been changing its policy framework from QQE to yield curve control. While the policy framework has been changing, the BOJ’s focus on lowering real interest rates to support the economy has been intact. Thanks to the recent recovery in breakeven inflation, real yields have been declining gradually.

10yr real yields are still around -0.50%, higher than the level recorded in 2014 (-0.80%). To keep the accommodative policy environment, the Bank is unlikely to change its 10yr yield target in the near future. Our economists judge that it would be premature to conclude that the BOJ will seek an early exit from the yield curve control.

The Reuters article also suggests the BOJ is likely to keep its policy targets unchanged (policy rate and 10yr yield target). 

The announcement of new JGB purchase operations to cap 10yr yields may be another catalyst of JPY weakness. If the BOJ tries to lower the real 10yr yield to -0.80% or below from the current level, the 30bp decline in the real yield could weaken JPY by 7-8 big figures, based on the relationship since 2015. 

We expect USD/JPY to reach 120 by end- 2017, while near-term overshooting is possible."