Japan’s central bankers meet this week, and what they decide has the potential to move markets around the world.
That’s because Japan is an outlier among major economies. While policymakers in the United States and elsewhere either are preparing to cut interest rates or have already done so, the Bank of Japan is only just beginning to raise them.
“Japan is in a different world,” said Kei Okamura, a portfolio manager based in Japan at the investment firm Neuberger Berman.
The Bank of Japan cut interest rates below zero percent in 2016 and kept them there until March, when it announced the first rate increase in 17 years, as the economy showed signs of recovery from anemic growth and low inflation. Economists believe the central bank might raise rates again at its upcoming meeting, which concludes Wednesday.
Policymakers at the Federal Reserve will meet later the same day to consider a rate cut to take the brakes off the U.S. economy. Even if both central banks keep rates steady Wednesday, most investors believe that they will act before too long, and market-based interest rates have moved accordingly.
The combination of a rise in Japanese interest rates and a decline in U.S. rates would compress a big gap — or spread, in market lingo — that investors have sought to exploit. A lot of money moves around the world based on tiny shifts in rate spreads: The dollar-yen is the second most commonly traded pair of currencies in the world, after the dollar-euro, accounting for more than $1 trillion in foreign exchange transactions per day.
Relatively low interest rates in Japan have been the primary reason for persistent weakness of the yen, which recently hit its lowest levels against the dollar in decades. That allowed investors — particularly Japanese investors — to use cheap yen to invest in higher-yielding assets abroad, in what is known as the “carry trade.”
But as rates in Japan and elsewhere shift, this trade could unwind — the yen has bounced up sharply versus the dollar in the past two weeks — with reverberations for stocks, bonds and other markets. Money could shift out of the United States, where Japanese investors are some of the biggest holders of U.S. government debt and major lenders to companies, potentially putting Wall Street under pressure.
A rising yen also hurts Japan’s stock markets, where export-oriented companies dominate. The Nikkei 225 index set a series of record highs this year, but has stumbled in recent weeks, shedding more than 10% from its peak in mid-July.
Market moves could be particularly pronounced in the summer months, when trading volumes are typically lower, amplifying the trading that does take place.
George Goncalves, head of U.S. macro strategy at MUFG Securities, warned of turbulence over the coming month, especially in currency markets as the yen strengthens along with higher Japanese interest rates.
“It is lining up in a way where it can turn and accelerate more if we get a hawkish BOJ and a dovish Fed,” he said.
However, others caution that central bankers in Tokyo and Washington are in no rush to shift policy, wary of stamping out the embers of growth (with rate increases in Japan) or reigniting inflation (with rate cuts in the United States).
“It will be a very gradual process,” Okamura said, adding that “global investors are keen to see how this plays out.”
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