Firm belief: A MUFG branch in downtown Tokyo. The bank expects the move to come in two weeks and says it is necessary for the BoJ to end the negative interest rate in March, and not April. — Bloomberg
TOKYO: One question is obsessing over Tokyo’s financial markets – when will the Bank of Japan (BoJ) exit negative interest rates?
The country’s biggest bank expects the move to come in two weeks and is positioning itself accordingly.
Mitsubishi UFJ Financial Group Inc’s (MUFG) view is much more definitive than the swap market, which rates the chances of BoJ governor Kazuo Ueda changing policy this month at about 50%.
When he does change course, it will have major implications for both the 1,096 trillion yen government bond market and for the nation’s currency.
“I think it’s necessary to end the negative interest rate in March, not April,” Hiroyuki Seki, head of global markets business at Mitsubishi UFJ Financial Group Inc, said in an interview.
Seki’s reasoning is that the BoJ will likely make an additional hike to take the policy rate to 0.25% by October at the latest “to secure future policy flexibility” after raising rates at its next meeting on March 19 for the first time since 2007.
The BoJ “needs to secure enough lead time before the next rate hike”, he said.
He said his outlook for the BoJ action is based on hints telegraphed by the central bank officials’ public remarks as well as political and other events this year, which are likely to dictate monetary policy options.
Traders of overnight indexed swaps see the chances of a March move around 53%, rising to an 80% chance of a hike by April as of late Tuesday.
Seki said there will be “structural changes” in the Japanese government bond (JGB) market once the BoJ ends negative rates and starts paying 0.1% interest rates on reserves. This will likely trigger a fall in demand for JGBs, pushing down their prices and driving up yields.
The yield on Japan’s benchmark 10-year government bond rose half a basis point to 0.7% yesterday.
MUFG is holding bearish positions on JGBs through investment funds and overnight-indexed swaps in anticipation of the BoJ move, Seki said.
“We are already managing in a way to enhance our tolerance to a rise in yen interest rates,” he said.
After short and medium-term rates start rising, MUFG will build up swap receiver positions, since overnight indexed swaps are undervalued relative to bonds, he said.
Seki added the bank plans to do that once 10-year overnight indexed swaps (OIS) reach at least 1.1% or five-year OIS at least 0.6%.
It also plans to start investing in JGBs “in earnest” if the securities’ overvaluation is corrected, with their yields converging toward corresponding swap rates, he said.
Yields on 10-year notes will likely trend towards 1% and over, and those on five-year to 0.6% and over, according to Seki.
Seki expected the BoJ to do more than just raise rates.
At the introduction of the negative interest policy in 2016, the BoJ adopted the three-tier system, wherein interest rates of 0.1%, 0% and minus 0.1% are applied on balances parked at the central bank reserves.
Seki said the BoJ is likely to get rid of the system along with the negative interest rate and a 0.1% interest rate is likely to be applied to all the money at the central bank reserve.
And the BoJ policy target is also likely to be changed to unsecured overnight call rates, which is expected to rise to a range of 0% to 0.1% from the current minus 0.1% to 0%.
Seki expected the BoJ to keep its yield curve control in place for a while to curb excess volatility in the aftermath of the policy change. — Bloomberg
