Bank of Japan Meeting: Kuroda May Find It Hard To Taper The Taper Talk

Bank of Japan's (BOJ) first monetary policy decision of 2018 is due tomorrow. The central bank will also release its quarterly economic outlook along with the policy decision.

Yen on the front foot

The Japanese Yen is looking stronger than ever ahead of the BOJ rate decision mainly due to speculation that the Bank of Japan will likely take steps toward winding down the massive monetary stimulus adopted in 2013 this year.

USD/JPY ran into offers above 113.00 on Jan. 9 after the central bank reduced the size of the bond purchases in its daily market operation. Though it was a routine operation, investors took it as a sign of future tightening and caused long-term interest rates and the yen to jump.

Also, at play are fears of rising yields driven risk aversion in the equity markets. The US 10-year Treasury yield has risen 25 basis points this month and looks set to extend gains further. Bond King Jeffrey Gundlach said earlier this month that rising yields could hurt equity markets... especially after the 10-year yield rises above 2.63 percent.

So far equities have not shown any signs of stress. But things may change if the 10-year yield moves above 2.76 percent.

10-year yield chart

• A break above 2.76 percent would signal long-term bullish reversal/inverse head and shoulders breakout.

The long-term bullish reversal in yields may hurt equities, thus Yen could find bids even in a rising treasury yield environment.

Communication challenge

Clearly, with risks skewed to the downside in USD/JPY, Kuroda and Co. have little room to signal policy normalization. At the same time, Governor will find it hard to convince markets that  QQE taper or policy normalization is unlikely to begin any time soon. Moreover, the markets have become extremely sensitive to even subtle signs the central bank may follow the footsteps of its US and European counterparts in unwinding the massive stimulus.

Accordingly, there is a risk that investors will read upward revision of inflation and/or growth forecasts as a sign the BOJ is preparing markets for the "great unwind", leading to broad based JPY rally (USD/JPY drop).

BOJ is widely expected to-

• Keep rates and yield curve control target unchanged.
• Is unlikely to reveal the conditions for future adjustment of the monetary policy.
• Revise up its economic growth outlook, but keep inflation forecast unchanged.
• Could say the downside risks to the inflation outlook have diminished (could be taken as a sign the BOJ has moved closer to policy normalization).

Only a downward revision of inflation forecasts could convince markets ultra easy policy is here to stay for a long time, although the odds of such a move are very low. That said, the technical charts favor futher rally in Yen. 

Technical outlook - USD/JPY Forecast: Bias remains bearish, attention shifts to 107.60