The Fed is about to pivot, and the Bank of Japan is embarrassed again: must it do it before the Fed?

While the central banks of Europe and the United States are "releasing doves," the Bank of Japan is about to "release hawks"? The market generally believes that the Bank of Japan will continue to be "maverick" in 2024.

The Bank of Japan will announce the results of the last policy meeting of the year on December 19, and the market generally believes that the Bank of Japan will not adjust its monetary policy at this meeting, maintain the benchmark interest rate at -0.1%, and maintain the yield on 10-year government bonds at around 0%.

More than 20% of analysts believe that the Bank of Japan will begin to phase out its ultra-loose monetary policy as early as January next year, while more than 80% of economists expect the Bank of Japan to eliminate negative interest rates by the end of next year.

Mari Iwashita, chief economist at Daiwa Securities, said he thinks it would be best for Kazuo Ueda to give instructions to the BOJ leadership this month to start thinking about removing the negative interest rate policy and inform the market in advance.

Tsutomu Watanabe, a former BOJ governor candidate and professor of economics at the University of Tokyo, said that "there is no time to lose," and that if Ueda does not take the step of normalizing monetary policy this time, he may not find a better time in his term.

Daisuke Karakama, chief market economist at Mizuho Bank of Tokyo, said that as the only major central bank that is still implementing a negative interest rate policy, the policy space of the Bank of Japan will be very tight after the Fed's pivot:

The BOJ is likely to stress that the policies of other central banks will not affect their own. But I think they would want to normalize before the Fed starts its rate-cutting cycle, if possible.

So will the "unpredictable" Bank of Japan give the market another year-end "gift".

Will the Bank of Japan not be "in a hurry" to raise interest rates at the end of the year?

In a recent speech to the Diet, Kazuo Ueda said, "It will become more difficult to deal with monetary policy from the end of the year to next year, and there are various options for adjusting policy rates if interest rates are raised." The word "year-end" in the remarks led to further bets that the Bank of Japan might "make a move" in December.

In the current situation, the Bank of Japan has a long way to go: on the one hand, it is imperative to end the long-term negative interest rate policy, and the continuous rise in inflation has caused dissatisfaction in Japan, on the other hand, there is also a risk of rushing to end negative interest rates, the domestic economy may be shocked, and the yen and Japanese bond yields may face a new round of market pressure.

Analysts generally believe that Kazuo Ueda will maintain negative interest rates and will not "rush to raise interest rates" by the end of the year. The Governor's and Deputy Governor's comments were aimed at preparing global markets for the normalization of the Bank of Japan's monetary policy next year, and it is too early to judge the expectations of a rate hike in December and January next year.

But what is certain is that the Bank of Japan has signaled an early farewell to the "era of negative interest rates", and investors will see historic rate hikes as early as the end of this year or early next year. Kazuo Momma, Mizuho Research & Economist Technology and former Head of Monetary Policy at the Bank of Japan, said:

In our view, the BoJ should be in full communication with the market, and from here on, the BoJ – like the Fed and the ECB – will continue to maintain a high level of transparency so that the market can fully price in the direction of its monetary policy. If the BoJ can confirm the ongoing trend of wage increases, the BoJ is expected to end negative interest rates in April and raise short-term rates slightly later in 2024.

HSBC pointed out in the report that the Bank of Japan likes to "raid" the market, but it is too early to exit negative interest rates at the end of the year, and they will wait until next year to confirm the wage-inflation relationship.

Is the Bank of Japan's most "challenging" period coming?

Analysts pointed out that there are two main reasons why the Bank of Japan has recently communicated with the market to withdraw from negative interest rates: (1) Japanese inflation continues to be at a high level, and (2) the Fed is more "dovish" than the market expects.

Question 1: Is inflation sustainable?

Judging from the Japanese economic data, on the one hand, there is still debate about whether Japan's inflation level of 2% can be sustained, and on the other hand, Japan's manufacturing PMI fell to the lowest level since February, and the weakness of the manufacturing industry is not good news for the Japanese economy.

As Japan's inflation has exceeded the Bank of Japan's 2% target for more than a year, recently, some Japanese inflation indicators have been higher than the United States, Japan's composite CPI in October was 3.3% year-on-year, higher than the United States' 3.2%, at the same time, the Bank of Japan's recent questionnaire survey of Japanese companies also shows that enterprises' inflation expectations and price increase expectations in 3-5 years are still at a high level.

There are views that this round of inflation in Japan may not be transitory, and it is necessary for the Bank of Japan to do something about relatively stubborn inflation, while others believe that there is still uncertainty about the trend of inflation in Japan, and the results of the "spring fight" in 2024 are more important.

In the report, UBS pointed out that it is too early to judge whether the positive feedback relationship between wages and prices is firmly established:

In fact, spring wage negotiations for the 2024 fiscal year haven't even begun yet, these negotiations start in January, but many companies, especially small ones, will continue into the summer.

The trade union federation Rengo will publish the results of seven statistical negotiations between March and July next year, the first of which will be announced on March 17.

Q2: If inflation is sustainable, when will the Bank of Japan act?

Nomura also pointed out in a recent report that they expect the Bank of Japan to end its negative interest rate policy in January next year, and the abandonment of the YCC policy will be relatively late until they can judge that the 2% inflation level can be sustained, while in Nomura's view, the spring collective negotiations will help the Bank of Japan judge that the wage-price cycle has entered a virtuous circle, predicting that the YCC will be canceled in the second quarter of 2024:

It is much more difficult to determine the likely timing of the BOJ's exit from negative interest rates, and the BOJ does not provide forward guidance in this regard, but we believe that the BOJ should exit the negative interest rate policy before exiting the YCC, and the BOJ will keep the YCC in order to serve as a "tailmove" for market stability if investors are too optimistic about rate hike expectations.

In the report, Nomura pointed out that there are three reasons why they have advanced the BOJ's exit from negative interest rates, including:

1) Bank of Japan Governor Kazuo Ueda pointed out in his speech to the Diet in early December that it will become more difficult to deal with monetary policy from the end of the year to next year. While it is not specified what would make the BOJ's job more challenging, we suspect that this comment suggests that the BOJ has accumulated a large amount of data to prove the formation of a virtuous cycle of wage-price spiraling. And there are reports that companies are increasingly willing to raise workers' wages in 2024. In our view, this project is likely to add to the data collected on the spiral between wages and prices.

2) Bank of Japan Deputy Governor Ryozo Himino also hinted that the Bank of Japan may soon end its negative interest rate policy, and the impact of exiting the negative interest rate policy on the Japanese economy is relatively small. If handled properly, exiting negative interest rates will have enough potential for a positive outcome, and a wide range of households and businesses will benefit from a virtuous cycle between wages and prices.

3) Changes in the market landscape, with long-end interest rates rising and the USD/JPY exchange rate falling (USD weakens, JPY strengthens) since the closely watched comments of two BOJ officials. This market reaction is likely to be excessive, but if the rise in long-term interest rates in the market and the fall in the USD/JPY exchange rate make the wage-price spiral look more certain, then the BOJ can mitigate the potential shock of withdrawing from the current easing policy to some extent.

Since December, the market has priced in a Fed rate cut earlier in 2024. Analysts believe that the Fed's interest rate cut period is also an important factor in determining the Bank of Japan's exit from negative interest rates:

At present, the portion of the BOJ's excess reserves corresponding to negative interest rates (Policy-Rate Balance) is only 4.5%, which is more of a marginal impact than an impact on stocks. We believe that the practical significance of negative interest rates is relatively limited, and even if negative interest rates are withdrawn, Japan's overnight interest rates will only rise by about 10bp, and the existence of negative interest rates is more symbolic.

In our view, the BoJ may want to end the existing negative interest rate regime in this inflation cycle (i.e., complete the exit of negative interest rates before the Fed cuts rates).

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