USD/JPY Fundamental Daily Forecast – Dollar/Yen Soars after Bank of Japan Stands Pat on Ultra-Easy Policy

The Dollar/Yen is soaring after the Bank of Japan surprised traders by keeping its yield curve tolerance band unchanged.

“Japan’s economy is projected to continue growing at a pace above its potential growth rate,” the central bank said in a statement.

The Bank of Japan (BOJ) also left its interest rate unchanged at an ultra-dovish -0.1%, in line with expectations and maintaining the same rate it’s kept since 2016.

At 05:08 GMT, the USD/JPY is trading 131.414, up 3.255 or +2.54%. On Tuesday, the Invesco CurrencyShares Japanese Yen Trust ETF (FXY) settled at $72.78, down $0.19 or -0.26%.

Speculators Unwinding Bad Bets

Ahead of the BOJ decision, speculation had been building about a change or end to Japan’s yield curve control (YCC) policy, given that investors have pushed 10-year bond yields above a ceiling set by the BOJ of 0.5% and the amount of bond buying to defend it has become staggering.

Under the YCC policy, the BOJ targets some short-term interest rates at -0.1% and the 10-year government bond yield at 0.5% above or below zero, aimed at achieving a 2% inflation target on a sustained basis.

After the surprise decision, the yen fell sharply as investors unwound bets they made anticipating the central bank would overhaul its yield control policy.

BOJ Crafts New Weapon to Defend Yield Control Policy

In a sign of its resolve to keep defending the cap, the BOJ crafted a new weapon or key market operation tool to more effectively curb rises in long-term interest rates.

Under the amended rules, the central bank can make both fixed-rate and variable-rate loans of up to 10 years’ duration against collateral to financial institutions.

“The BOJ shall determine the interest rate of each loan in order to encourage the formation of a yield curve that is consistent with the guideline for market operations, taking into account market prices of Japanese government bonds for each maturity,” the central bank said in a statement.

Japan Yields Tumble Most in Two Decades

Japanese government bond yields tumbled the most in two decades on Wednesday, retreating sharply from the central bank’s 0.5% ceiling after policymakers decided to keep its yield curve controls in place.

The 10-year yield was last down 13 basis points at 0.37%, which would mark the biggest one-day decline since November 2003, and earlier dipped as low as 0.36%. It was at 0.51% prior to the BOJ decision.

Short-Term Outlook

The steep drop in Japanese government bond yields is the real shocker on Wednesday, with the move widening the spread against U.S. government bond yields, and making the U.S. Dollar a more attractive investment against the Japanese Yen once again.

If the BOJ had expanded the band again or terminated YCC, yields would rise, which would have made the move similar to a rate hike.

But policymakers didn’t do that, which sends a clear signal that they didn’t want to complicate matters for the new governor after Governor Haruhiko Kuroda retires in April.

Furthermore, it doesn’t mean officials won’t need to tweak YCC in the near future, but they would prefer the new governor handles any tweaks after he scrutinizes economic conditions.