Weekly Kick Start | 7 October 2023

After weeks of market volatility, this week brought some relief for equity investors with positive gains. Among the top concerns this week are speculation about the next steps from the Bank of Japan (BOJ), anticipation surrounding developments at FTX, and the news that ExxonMobil is closing in on a $60 billion deal to acquire Pioneer Natural Resources, a move that could make it the leading U.S. oil producer.

On Top of Our Mind This Week: The Potential Path for Bank of Japan

USD/JPY 5 Year Chart (Source: Refinitiv)

Revisiting the Interest Cap: The Bank of Japan is potentially contemplating raising the limit on long-term interest rates, which is currently set at 1%. They would do this if the interest rate on 10-year bonds gets too close to this limit. The Bank follows a system called yield curve control (YCC). In this system, they keep short-term interest rates very low at -0.1%, and they try to keep the interest rate on 10-year bonds around 0%. They also have a range of 50 basis points on each side of the target, along with the 1% limit. This shows that the Bank is ready to adapt to changing economic situations.

The Reason for the Change: The recent decision to raise the interest rate cap to 1% was because of the policymakers getting worried. They are concerned that keeping interest rates extremely low might cause the value of the yen to drop a lot, like it did last year. This change in how they control bond yields came after discussions and a change in leadership at the bank. The Japanese government, especially Prime Minister Fumio Kishida’s team, has also pushed for this change. They want the Bank to pay more attention to market movements, especially those related to the yen, when making monetary policy decisions.

Effects on the Market: The Bank of Japan’s recent decision to change the interest rate cap has had a significant impact on financial markets. It is a shift away from the aggressive monetary easing implemented in the past decade. It shows that the central is now focusing on dealing with the side effects of keeping interest rates low for a prolonged period. These side effects include Japan’s interest rates being much lower than those of other countries. Policymakers now have a challenge: they need to control inflation and make sure it does not go too high, while slowly moving away from policies that have been very accommodating.

The Future Potential Path: This recent change in policy suggests that the Bank of Japan might let the interest rate on 10-year government bonds get closer to 1% before they step in to control it. This change in approach shows that the Bank is adjusting its priorities to match the changing economic situation. More significant changes in policy, like raising interest rates, will likely happen after careful analysis of data on wages and expected inflation for the next year. While the direction is clear, it will take some time, maybe the full five-year term of the new bank leadership, to complete this transition.

Market Recap This Week

Last week, the Nasdaq and S&P stock indices rebounded after a period of decline, while the Chinese market remained closed throughout the week. The US Treasury bond yield continued to rise as the market adjusted to the Fed’s “higher for longer” guidance and concerns about potential additional Treasury bond issuance. Commodities like oil and gold faced challenges, with oil dropping by approximately 8.8% due to lower demand and gold declining by 1%. On the other hand, Bitcoin saw a 3.9% increase, reaching a price of $27,941.

Source: Google Finance, Syfe Research, 7 October 2023 

What is on the Radar for This Week? 

In the upcoming week, keep an eye on the release of CPI (Consumer Price Index) and initial jobless claims data. These key economic indicators are crucial for assessing the strength of the economy and will provide insights into the potential actions of the Federal Open Market Committee (FOMC).Strong economic data could increase the likelihood of the Fed hiking rates once more by the end of 2023. Stay tuned for these releases as they may have significant implications for the financial markets and monetary policy decisions.

Source: Reuters, Academic lto, Bloomberg, Google Finance

Image source: Reuters file photo

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