【MACRO Insight】Rising Global Financial Market Uncertainty, Optimistic Yen Outlook, and the Return of Its Safe-Haven Status?

Mercer LLC has publicly expressed a firm optimism towards the yen, anticipating multiple interest rate hikes by the Bank of Japan in the coming years. This strategy reflects the company's profound insight into the global financial market and its confidence in the Japanese economy. Mercer forecasts that the Bank of Japan will gradually raise the benchmark interest rate to 1.5% or higher over the next few years. The company is also confident in the first interest rate hike of the year by the Bank of Japan and expects this week's policy meeting to be a pivotal turning point.

Since last October, Mercer's outsourced Chief Investment Officer business unit has held long positions in the yen across multiple multi-asset funds, demonstrating the company's consistent global view on the Bank of Japan's policy. Mercer anticipates that the Bank of Japan's policy rate will reach 1.5% in the coming years, reflecting its expectation that inflation in Japan will become deeply entrenched. In contrast, the median forecast from Bloomberg's survey for the central bank's terminal rate is 1%. Mercer believes that the Bank of Japan can achieve a 2% inflation target on a sustainable basis. A virtuous cycle between wage growth and service price increases is in place, making the inflation target sustainable.

Against this backdrop, Bank of Japan Governor Haruhiko Kuroda will announce his quantitative tightening plan and interest rate policy decision on Wednesday. This move may trigger fluctuations in the global financial market, and he will face strict scrutiny. The market generally expects the Bank of Japan to reduce its monthly bond purchases from the current 6 trillion yen ($32.6 billion) to about 5 trillion yen, eventually halving the purchase volume within two years. Any figure significantly deviating from these expectations could trigger bond market volatility. The yen's astonishing rebound last week, along with its impact on carry trade and global stock markets, makes the Bank of Japan a potential variable this week.

Although only 14 economists predict that the Bank of Japan will raise the interest rate from the current range of 0 to 0.1%, almost no one has ruled out this possibility. As for quantitative tightening, the Bank of Japan will outline a plan to reduce monthly bond purchases over the next one to two years. Investors are closely watching the policy decisions of the Bank of Japan. Market sentiment remains fragile, and ultimately, the U.S. stock market is key. Data released last Friday showed that investors have significantly reduced their short positions in the yen, and the current level of bearishness is the lowest since February, marking an astonishing turnaround in market sentiment. Kristina Clifton, Senior Economist and Chief Currency Strategist at the Commonwealth Bank of Australia, said that the Federal Reserve's interest rate decision is a “big event” that poses a risk to the USD/JPY currency pair. She added, “Any hint of easing from the FOMC could significantly lower the US dollar against the yen, but a hawkish FOMC may not have much impact.”

In addition, investors are also on alert for further geopolitical turmoil. Israel is considering how to respond to the fatal rocket attack on the Golan Heights, which Israel and the United States attribute to the Lebanese armed organization Hezbollah. Shinichiro Kadota, a currency and interest rate strategist at Barclays in Tokyo, pointed out, “Market sentiment remains fragile, and ultimately, the U.S. stock market is key.” He mentioned the demand for safe-haven currencies such as the yen during last week's stock market crash and added, “Market trends have always been dominated by the U.S. stock market, and we need to see if the situation there stabilizes.”

Before the meeting, the yen fluctuated, rebounding from a 38-year low to a two-month high, driven by speculation that the huge interest rate differential between Japan and the United States is about to narrow. Earlier this month, insiders said that some officials of the Bank of Japan were open to raising interest rates if inflation is in line with expectations. Insiders said that others believe that the central bank can maintain the status quo because the authorities are waiting for more data, hoping to confirm signs of a pickup in consumer spending.

Haruhiko Kuroda has shown himself to be a cautious person in the year and a bit since he took office. Raising interest rates while tightening policy will convey a more aggressive stance than necessary. Kuroda has taken a year to raise the interest rate from slightly below zero to 0.1%. Will he really turn hawkish strongly？ But according to market news, there will definitely be discussions within the central bank. An interest rate hike would indicate that Kuroda may be more hawkish than most observers of the Bank of Japan have imagined so far, and it may trigger market speculation that the Bank of Japan may raise interest rates again before the end of the year.

In recent weeks, the yen has appreciated rapidly against the US dollar. A rate hike in July will enable the Bank of Japan to argue that it is not influenced by the weakening of the yen when making interest rate decisions. It is suspected that the Ministry of Finance of Japan has carried out continuous currency intervention earlier this month. Given this, it is expected that Kuroda will convey a hawkish sentiment, even if he decides to maintain the status quo on Wednesday, he may also hint at an imminent rate hike. The Bank of Japan is expected to adjust its quarterly inflation forecast to reflect Prime Minister Fumio Kishida's decision to restore public utility subsidies this summer. This may lead to a slight downward adjustment of this year's forecast and a possible increase in next year's forecast. However, political pressure may affect Kuroda's decision-making. The ruling Liberal Democratic Party's Secretary-General, Toshihiro Nikai, and the Minister of Digital Affairs, Taro Kono, have recently called on the Bank of Japan to tighten policy to support the yen and curb inflation, both of whom are potential candidates for the Prime Minister of Japan.

Historical lessons show that the Ministry of Finance of Japan only used its power to seek a postponement of interest rate hikes at an ill-timed historic meeting in August 2000 when Japan abandoned its zero-interest-rate policy. At that time, the government had asked for a postponement of the rate hike, arguing that the current economic data was too early, but it was rejected by the policy committee. It is worth noting that among the officials who voted against the rate hike at the time was Kuroda. His views were not entirely different from those of the then-Governor of the Bank of Japan, Masaru Hayami. Kuroda just expressed the hope for a little more patience to ensure that the positive trend has been established. For now, Kuroda had better adopt the method of the first President of the European Central Bank, Wim Duisenberg. Due to sluggish economic growth, this Dutchman faced tremendous pressure from the ministers of the Eurozone. In 2001, Duisenberg was asked by a reporter about his reluctance to cut interest rates, and he said, “I heard it, but I ignored it.”

The more academic-minded Kuroda may find it difficult to refute in the same way. However, he can reflect the actual situation. So far, Kuroda has remained cautious, and now is a good time to ignore those voices calling for interest rate hikes. Could the strong yen continue to impact the market？ If the policy mix of the Bank of Japan and the Federal Reserve is favorable to the yen, the yen seems ready to rise sharply again. Although the yen's short position has decreased significantly from the historical extreme, the shorts are still in a vulnerable state. A comprehensive indicator measuring the yen's position - using CFTC data and Citigroup's tracking of the pain index of active foreign exchange traders - has reached a bearish level that has only appeared five times before. Except for March 2021, each time it led to a reversal and finally turned to a long position, when the expectation of an upcoming Federal Reserve rate hike cycle re-triggered bearish bets.

In the past few weeks, the global market has been filled with uncertainty, coupled with obvious political turmoil, which may also exacerbate the situation. The yen has regained its halo as a safe-haven currency, which many people thought had long disappeared. This makes risk assets more susceptible to concerns about the Federal Reserve's shift to a loose policy, indicating that the U.S. economy may face a severe slowdown, and the economy will “land,” which may be a hard landing rather than a soft one. Investors may hope that Kuroda will bring disappointment to the doves again, or hope that the earnings reports of U.S. tech giants and labor force data are gentle enough to offset any repetition of last week's painful trading with the strengthening of the yen.