Since the beginning of the month, the yen has seemingly reversed its long-term downtrend, beginning a strong rally. After a robust rally for five consecutive trading days, the yen held its ground above 140 against the U.S. dollar on Thursday, July 13.
Although there are no signs that the Japanese bond market is under the same kind of pressure as it was earlier this year, the yield on 10-year government bonds has slightly rebounded to near the 0.5% level set by the Bank of Japan. On Monday, the yield on these bonds touched 0.465% for the first time since April. On Thursday, the price of the 10-year swap was slightly below 0.7%, reaching its highest level since March this year, which reflects traders betting on a further widening of Japanese bond yields.
Many analysts believe that a possible reason behind the rally of the yen and Japanese bonds is that the market is speculating that the Bank of Japan might further adjust its Yield Curve Control (YCC) policy at this month's policy committee meeting, following its expansion of the long-term yield cap to 50 basis points (0.5%) in December last year.
The Bank of Japan will make decisions on interest rates and YCC policy at the end of the interest rate meeting on July 28.
In recent years, Japan has maintained a loose monetary policy, while the U.S. and Europe have been hiking interest rates. The expansion of the interest rate differential has led to the selling of the yen. The market believes that if the Bank of Japan adjusts its policy, it will narrow the spread, making the yen more attractive.
The yen also showed similar strength in June 2022 and January this year when short selling of bonds by foreign investors pushed yields to their upper limit, raising market expectations for a policy adjustment.
Japanese Economic Data Supports Adjustment of YCC Comparing last year with this year, although there have been continuous speculations about YCC policy adjustments, there have been significant changes in the Japanese economy.
Data released last week showed that Japan's inflation is still higher than expected, and an indicator measuring Japanese wages has seen its fastest increase since 1995. In addition, a survey by the Bank of Japan showed signs of a virtuous economic cycle in Japan, with strong business investment and recruitment plans, and a rebound in manufacturers' confidence for the first time since 2021.
The Bank of Japan's Deputy Governor Masazumi Wakatabe recently did not rule out the possibility of adjusting the YCC policy, but he also said that it is currently impossible to raise negative interest rates.
Analysts from Société Générale, Kit Juckes and Olivier Korber, wrote in a report on Wednesday that market speculation about a YCC policy adjustment at this meeting is more than the last meeting. Compared with the last meeting, there are not as many voices refuting the market's speculation about adjusting the YCC policy.
However, not everyone is convinced that the Bank of Japan will adjust or even abolish the YCC policy this month.
Nobuyasu Atago, chief economist at Ichi Securities and a former Bank of Japan official, said the market performance before the Bank of Japan's July meeting is very important for the bank's policy decision.
Adam Cole, chief currency strategist at RBC Capital Markets, believes that compared with the increase in bets on policy adjustments, the covering of short yen positions is a more reasonable explanation for the yen's strong rally in recent days.
Barclays Bank's chief Japanese economist Tetsufumi Yamakawa said on Thursday that the Bank of Japan has taken an obvious lagging stance, and it seems unlikely that it will be forced to modify the YCC according to the current wage and price indicators. We believe that the Bank of Japan's policy adjustment is not in July, but October.
Earlier this week, analysts from Bank of America also predicted that the Bank of Japan will adjust the YCC policy in October, not this month. Bank of America economists Izumi Devalier and Takayasu Kudo wrote in a report on Monday:
Daisaku Ueno, chief currency strategist at Mitsubishi UFJ Morgan Stanley Securities, doesn't believe the yen will get much stronger right now. He stated:
