By Richard Leong
NEW YORK (Reuters) - The Bank of Japan may steal the thunder from the U.S. Federal Reserve and its chair Janet Yellen this week if it chooses to give more monetary stimulus in its latest effort to jumpstart its economy and the U.S. central bank decides to stand pat on interest rates.
If the BOJ, led by Governor Haruhiko Kuroda, decides to shake up its policy stance, one avenue would be to be less aggressive in purchasing longer-dated assets, thereby allowing yields to go up, while cutting short-term rates deeper into negative territory.
This would likely result in a rise in yields of U.S. Treasuries and other government bonds, and on the margin push up long-term borrowing costs for consumers and corporations.
Japanese investors have poured money into foreign bonds in a scramble for income-generating assets as domestic bond yields have turned negative. This is contributing to holding global yields near historically low levels.
"The BOJ is important in part because the Japanese have been buying anything abroad that gives them yields," said David Keeble, global head of interest rates strategy at Credit Agricole (PA:CAGR) Corporate & Investment Bank in New York.
Last week, the yield on 10-year Japanese government debt rose close to zero percent, a level not seen since March, in a global bond market sell-off triggered by the European Central Bank's decision to refrain from expanding its asset purchase program on Sept. 8.
The ECB's move intensified worries that major central banks are running out of tools to aid their economies.
"Japan has struck a chord in terms of the generalised perception that there isn't that much left in that tank for policymakers from a monetary standpoint. Therefore if you still need to provide stimulus, perhaps monetary policy isn't the way it is going to be forthcoming," Charlie Diebel, head of rates at London-based asset manager Aviva (LON:AV) Investors.
The U.S. economy is far from robust, posting a sub-par 1.2 percent increase in second quarter gross domestic product. However, Japan, the world's third biggest economy, is struggling even more, eking out just 0.7 percent growth in the same period.
The BOJ will undertake a comprehensive review of its current monetary policy at the its Sept. 20-21 meeting, amid speculation it may lower short-term interest rates deeper into negative territory and change its bond purchasing program.
Fed Chair Yellen and other U.S. policy-makers, who will convene during the same period as their Japanese counterparts, are widely expected to leave their benchmark policy rate unchanged in a range of 0.25-0.50 percent. They will likely keep the door open for a rate increase by year-end.
To be sure, if the Fed stuns investors by raising rates within hours of their Japanese counterparts' decision, that would overshadow anything coming from Tokyo.
The consensus is the Fed will keep its powder dry given the recent patch of soft economic data. Also, it may be reluctant to raise rates, and possibly upset financial markets, ahead of a tightening presidential election on Nov. 8.
"I don't think there will be anything revolutionary enough to move markets," Paresh Upadhyaya, portfolio manager at Pioneer Investments in Boston, said of the upcoming Fed meeting.
UNCONVENTIONAL OR INEFFECTUAL?
Japan's struggle has persisted even as the BOJ adopted unconventional measures of negative interest rates and massive asset purchases aimed at spurring consumption and investments, while also helping exports with a weaker yen.
Instead the yen has risen 15 percent against the dollar <JPY=> and 13 percent versus the euro (EURJPY=) so far this year.
"They may be caught in a vicious feedback loop with the yen," said John DeClue, chief investment officer at the Private Client Reserve at U.S. Bank in Minneapolis.
In recent days, there have been reports that stoked speculation the BOJ might consider lowering its current -0.10 percent target rate
Interest rate markets implied traders expect a 17 percent chance the BOJ would lower its target rate to -0.30 percent on Wednesday and a 14 percent chance the Fed would raise the federal funds rate by a quarter point, according to Reuters data.
"I don't think they have too many more big options left," said Robert Tipp, chief investment strategist at Prudential (LON:PRU) Fixed Income in Newark, New Jersey.