The priced-in market view implied in Fed Funds futures following the announcement (June’s FOMC meeting,) is more aggressive still, envisioning one hike in 2022 and two more in the following year. As it happens, the process that the Fed is slowly initiating finds most global policy rates having converged on Japan – that is, toward zero and sometimes beyond it, into negative territory – amid the onset of the Covid-19 pandemic. Recovering from these depths in most places is expected to come alongside reflation.
Japan is a familiar exception. Here, structural forces holding down prices for the better part of 30 years and inspiring an epic (and mostly fruitless) BOJ counteroffensive remain in play. What this means is that real interest rates – that is, nominal yields discounted by the expected rate of inflation – are higher in Japan than most of the G10. Since most nominal rates have converged near zero, the size of the inflation haircut has become pivotal. That is inherently small in Japan relative to global counterparts, so the inflation-adjusted yield to be had on JPY-denominated holdings emerged as more attractive. The BOJ policy of capping 10-year yields at 0% is an obvious headwind here, but it seems fragile. The central bank already owns almost half of Japan’s bond issuance to sustain it. Scope to do more seems limited, lest the monetary authority and the government itself be accused of outright debt monetization, an international taboo.
Of the major currencies, the Yen’s most pronounced advantage in this sense seems to be against the British Pound. As inflation fears push the Fed moves to pressure nominal rates upward globally, Japan’s real-yield advantage seems likely to expand further.
GBP/JPY Short (Sell)
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