Bank of Japan Target Rate (AUG 22)
Expected: 0.50%
Previous: 0.50%

How Will The Markets React?

The Bank of Japan’s August rate decision is not likely to be a major market mover, though commentary from central bank Governor Toshihiko Fukui could add volatility. While there is no official time of release, the rate announcement tends to hit the new wires just after 23:30 EST on the release date. For the past six months, the BOJ has kept interest rates unchanged at 0.50 percent - by far the lowest overnight lending rate amongst the industrialized countries - after hiking the benchmark 25 basis points in February. The Bank's neutral stance has not been entirely surprising after CPI has consistently indicated that the Japanese economy is still dangerously close to deflation. In fact, Tokyo core CPI (excluding fresh food and energy) fell -0.3 percent on an annual basis, marking the sixth consecutive month of contracting prices. Nevertheless, Fukui has consistently stated that the central bank would adjust interest rates gradually based on the pace of improvement in the economy and prices, signaling that an upturn in inflation could trigger policy tightening. Furthermore, Fukui is widely perceived as remaining determined to secure his legacy of “normalizing” monetary policy after successfully putting an end to zero-interest rate policy (ZIRP) in 2006, despite major resistance from political and fiscal officials. In fact, LDP Secretary General Hidenao Nakagawa – who is under pressure to resign – directly blamed previous BOJ rate hikes for the LDP losses in the recent upper house election, saying that the bank left the government unable to achieve its growth target. While we don’t doubt Fukui’s determination to bring interest rates higher, we don’t believe that the central bank has a chance of doing so in August. However, if Fukui sounds remotely hawkish in the central bank’s monthly report, markets may consider the possibility of a September hike.

Bonds – 10-Year Japanese Government Bond Futures

Japanese government bond futures have continued their bullish ascent amidst widespread risk aversion in the markets. On the intraday charts, 135.62/64 has developed into a floor while the daily chart is forming a bullish trend continuation pattern. JGBs will encounter event risk as the BOJ will announce their August rate decision and will also release their monthly report. The central bank is widely expected to leave the target rate at 0.50 percent, but if the BOJ signals that they desire to normalize rates in the near term, JGBs could ease back towards support. However, the main theme for global financial markets remains focused on fears of a liquidity crunch. As a result, JGBs may still stand to gain further.

FX – USD/JPY

Following the recent carry trade unwind, USD/JPY has consolidated tightly just below 114.50 as volatility has died down significantly. Furthermore, with economic data out of the US very thin this week until Friday, many of the USD pairs remain contained to range trading. However, the Japanese yen faces some event risk, as the Bank of Japan is scheduled to announce their target rate on August 22nd around 23:30 EST. While the central bank is highly unlikely to adjust monetary policy given the rocky state of financial markets along with continued deflation in the Japanese economy, traders should keep an eye on the newswires as BOJ Governor Toshihiko Fukui remains somewhat determined to further normalize rates. An unexpected increase in the overnight lending rate could propel the Japanese yen and take USD/JPY back down to the recent lows near 112.00. However, the more probable scenario would be for the central bank to leave rates unchanged, which should not spark much price action in USD/JPY. As a result, the pair may simply continue to trade range bound until the end of the week, with risks of a break up to the 117.00 level barring another spike in volatility on liquidity crunch fears.

Equities – Nikkei 225

The descent of the Nikkei 225 has been rapid and steep, however, the equity index gained 1.1 percent on Tuesday as exporters were boosted by a slightly weaker Japanese yen. However, the Nikkei 225 was not able to close above former trendline support at 15,920.38. A push above this level could target Fibonacci resistance at 16,409.00, but this will likely remain contingent upon risk aversion in the markets. Looking ahead, the Bank of Japan’s target rate announcement creates minor event risk, as the central bank is widely anticipated to leave rates steady. However, BOJ Governor Toshihiko Fukui’s sheer determination to normalize rates, despite slowing growth and signs of deflation, has left markets speculating about an increase this year. If we see the BOJ leave the target rate at 0.50 percent as expected, the Nikkei 225 is unlikely to show much reaction, while a surprise increase to 0.75 percent (which is highly unlikely) could send the index plummeting.

Terri Belkas is a Currency Strategist at FXCM.