Abhay Singh
Japan’s position as an outlier among major countries means that the central bankers’ meeting this week could have an effect on global markets. Unlike the US and other countries, Japan is only beginning to raise interest rates, unlike other major economies that have already done so.
“Japan is in a different world”
The Bank of Japan cut interest rates below zero in 2016 and maintained them until March, when it announced its first rate increase in 17 years due to recovery from anemic growth and low inflation. Economists predict the central bank may raise rates again at its upcoming meeting.
Kei Okamura, a portfolio manager based in Japan commented “Japan is in a different world.”
Soon Federal Reserve policymakers would convene to discuss reducing interest rates in an effort to loosen the reins on the American economy. Market-based interest rates have climbed in line with investor expectations that the two central banks will move sooner rather than later, even if they maintain their current rate on Wednesday.
The dollar-yen is the second most traded currency globally
A rise in Japanese interest rates and a decline in U.S. rates could compress a significant market gap that investors have exploited. The dollar-yen is the second most commonly traded pair of currencies, accounting for over $1 trillion in foreign exchange transactions per day.
Low interest rates in Japan have led to the yen’s persistent weakness, allowing Japanese investors to use cheap yen for higher-yielding assets abroad.
However, as rates in Japan and elsewhere shift, this trade could unwind, with the yen rebounding sharply against the dollar in the past two weeks. Money could also shift out of the United States, where Japanese investors are major lenders to companies and some of the largest holders of U.S. government debt.
Rising exchange rates can negatively impact Japan’s stock markets, which are dominated by export-oriented businesses. This year, the Nikkei 225 index broke several records, but it has faltered recently, losing over 10% of its value from its mid-July peak.
“It will be a very gradual process”
Market movements could be pronounced in the summer months, as trading volumes are typically lower. George Goncalves, head of U.S. macro strategy at MUFG Securities, warned of turbulence in currency markets, especially as the yen strengthens and Japanese interest rates rise. He suggested that a hawkish B.O.J. and a dovish Fed could accelerate the situation.
However, central bankers in Tokyo and Washington are not in a rush to shift policy, fearing that it could stifle growth or reinite inflation. A gradual process is expected, and global investors are keen to see how this unfolds.
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