Yen performs U-turn on BoJ policy rethink while Fed decision looms

The Japanese yen performed quite a U-turn during today’s trading, as policy that was first thought to be a yen-negative was later reassessed as a yen-positive. Other currency pairs that did not involve the yen were mostly waiting for the Fed’s decision on interest rates later in the US session. The pound was trying to recover following its recent heavy losses on views that Brexit could ultimately involve a more distant economic relationship between the EU and the UK than originally thought.

As the market focused on the Bank of Japan’s decision to turn away from targeting its monetary base and towards targeting the yield curve, dollar / yen initially rallied to a high of 102.78. The new policy was an attempt to target long-term interest rates, in addition to promises of overshooting the 2% inflation target and if necessary, cutting short-term rates deeper into negative territory. However, this untested policy could also have negative consequences as the Bank of Japan will own an increasing percentage of Japanese government bonds, meaning it could just as well set the price where it pleases in a market of ever-decreasing liquidity. In addition, it is not clear why keeping the 10-year rate near zero would yield more benefits compared to its existing policy of keeping short-term rates at zero. Furthermore, the 10-year JGB yield has spent most of its time since March this year in negative territory so it is again unclear what extra benefits the new policy of a zero target for the 10-year yield would bring. Markets turned justifiably sceptic towards the BoJ’s moves, although to be honest the Bank could do more easing in the future given the new policy framework it has adopted (more negative rates for example or targeting even longer-term interest rates such as 15- and 20-year). Dollar / yen slipped more than 2 yen from its high to 100.56 and other yen crosses ended similarly negative.

The US dollar was transfixed on the crucial Fed meeting outcome later in the day. An interest rate hike was seen as highly unlikely, even though many market observers believed that the Fed ought to raise interest rates today. The consensus view was that the Fed would refrain from hiking and would most probably prepare the markets for a rate hike in December – in a data-dependent manner of course. In addition to the actual policy statement and assessment of current economic conditions, there was a lot of interest in where the individual committee members would see long-term interest rates in the new set of forecasts that is issued every quarter. There was speculation that the Fed would lower its long-term interest rate forecast, given some research lately that suggests that the long-term neutral interest rate might be lower than first thought. That would in turn mean that any rate hike cycle would be slower and end at a lower level compared to previous cycles. Euro / dollar was trading around 1.1140, while the pound was around 1.2980 in a struggle to regain the 1.30 mark versus the greenback.

Oil was helped to rebound by a substantial draw in weekly US crude inventory numbers, while gasoline stocks also fell more-than-expected. The larger-than-expected build in distillate stocks (around 2 million barrels), did not compensate the big draw (around 10 million barrels) in crude oil and gasoline combined. US oil futures climbed above $45 a barrel from around $44.75 a barrel before the inventory data.

Looking ahead, apart from the Fed’s decision, statement and Chair Yellen’s press conference and the consequences for the US dollar, focus will turn on the antipodean currencies. The Reserve Bank of New Zealand is due to meet early during Thursday’s Asian session, while there will be a speech from the new Governor of the Reserve Bank of Australia Philip Lowe.