YCC to be abolished at the July meeting?

Summary

The Ueda BOJ's first move was to maintain the status quo. It appears that the BOJ is still not convinced that it will stably achieve its 2% inflation target. The USD/JPY came under upward pressure because some investors had seen the outside possibility of a policy change. I expect the USD/JPY to continue to swing back in the short term. However, I do not expect strong downside pressure on the yen because expectations for a change in monetary policy soon have not been extinguished. Meanwhile, the FOMC in May is expected to raise rates by 25bp and halt further hikes from there. I expect the Fed will continue to rein in expectations of rate cuts, but with the market's focus shifting to the timing of rate cuts, I continue to expect a moderate decline in the USD/JPY as a medium-term trend.

April in review

The USD/JPY opened the month at 133.34. The dollar weakened as US indicators released from the start of April, such as the ISM manufacturing index, the job openings and labour turnover survey, the ADP employment report, and the ISM nonmanufacturing index, fell short of market expectations across the board. The USD/JPY fell to 130.64 on 5 April. However, the US employment statistics for March released on 7 April showed a fall in the unemployment rate along with a rise in the participation rate. The dollar rose across the board as this suggested that labour market conditions remain tight. In addition, on Monday 10 April, new BOJ Governor Kazuo Ueda's inaugural press conference was interpreted as dovish, causing the yen to weaken and the USD/JPY shot up to around 134. The pair fell back to around 132 after both the US consumer price index (CPI) announced on 12 April and the US producer price index (PPI) announced on 13 April fell short of market expectations, but the USD/JPY strengthened again after Fed Governor Christopher Waller said on 14 April that further monetary tightening was necessary and the University of Michigan survey showed a rise in inflation expectations. The USD/JPY gained further momentum and rose to 135.14 on 19 April, after the New York Fed's empire state manufacturing index for April, announced on the 17th, exceeded market expectations. However, the USD/JPY then became top heavy as the number of new jobless claims announced on 20 April reached the highest level since November 2021, and the Philadelphia Fed index missed expectations. This was followed by renewed concerns about regional US bank operations. The USD/JPY came under downside pressure as UST purchases picked up in a move to risk off, temporarily falling to around 133 on 26 April. Movement paused on the morning of 28 April as the market waited on the BOJ's monetary policy meeting, but the USD/JPY rose sharply after meeting outcome was announced around 13:00 JST. The USD/JPY had recovered to above 135 at the time of writing this report (Figure 1).

The prevailing view in April based on Governor Ueda's remarks and speculative reports was that the BOJ would hold off on making any change in monetary policy. ECB officials repeatedly took a hawkish stance during this period, and as a result the EUR/JPY rose to above 148 for the first time in about eight years. Meanwhile, the AUD was weak following the RBA's decision to suspend rate hikes, suggesting that differences in monetary policy stance are having a strong impact on the positions of major currencies (Figure 2).

FIGURE 1: USD/JPY (DAILY)

FIGURE 2: MAJOR CURRENCIES' RATE OF CHANGE VS USD IN APRIL

Foreign exchange market remains sensitive to monetary policy stances

USD/JPY in April had recorded a low of 130.74 and a high of 135.14, moving in a range of 4.50 yen, which is the narrowest range since February 2022. In the first half of April, the USD/JPY was exposed to upward pressure as concerns about the financial system in March receded, but even so, the sharp swing back seen in February and March did not occur. The FOMC meeting on 2-3 May is almost certain to vote on another 25bp rate hike, but the prevailing view is that the rate hike cycle will end at that point. Such changes in the situation surrounding the Fed's monetary policy are likely exerting downward pressure on the dollar. Meanwhile, the yen faced selling pressure as BOJ Governor Ueda's comments dispelled expectations that the BOJ would move to revise monetary policy soon after the new governor took office. Of course, expectations for a change in monetary policy soon have not completely disappeared, meaning the yen is unlikely to weaken sharply in the short term. However, with the ECB still maintaining its hawkish stance, the EUR/JPY has hit an eight-year high. This suggests that monetary policy stances in Japan and overseas remain a driver in the foreign exchange market. In other words, I would expect the market's attention to shift to the FOMC once the reaction to Governor Ueda's press conference has run its course.

Fed to finally halt rate hikes at FOMC in May

Overall, the US economy does not seem in need of monetary tightening, at least not to the extent the Fed assumed at the time of its most recent economic outlook compiled in March. It therefore seems reasonable to assume that the Fed will end rate hikes at the FOMC meeting in May, when the federal funds rate will reach the upper limit of 5.25%, which is the terminal rate of the current rate hike cycle suggested by the dot plot.

From the perspective of dialogue with the market, the focus will likely be on the extent to which the FOMC statement and Fed Chair Jay Powell's subsequent press conference fosters a sense that the rate hike cycle is coming to an end. Messaging that could be taken to suggest that the Fed will continue hiking rates at the next meeting in June would probably add fuel to resurgent concerns about the financial system. Therefore, I expect the Fed to make it clear that it plans to end its rate increases.

The new BOJ regime leaves monetary policy on hold for now

The BOJ voted to leave policy unchanged at Kazuo Ueda's first board meeting as governor. It dropped the forward guidance that had said the Bank "expects short- and long-term policy interest rates to remain at their present or lower levels," and indicated that it would conduct a broad-perspective review of monetary policy since the new BOJ Act came into effect in 1998, over a time frame of 12 to 18 months.

Rumours of a possible revision or abolition of the YCC had spread through the financial markets, with the memory of former governor Haruhiko Kuroda's knack for surprises still fresh in mind. However, in the end, the BOJ left policy on hold, in line with the consensus. The removal of forward guidance and a review of monetary policy had already been discussed in speculative media reports before the meeting, so probably did not come as a surprise. The BOJ's outlook for prices is a key input for its monetary policy decisions, and its Outlook for Economic Activity and Prices (Outlook Report), released at the same time as the policy decision, showed that the Bank has revised up the outlook for FY23 and FY24 (Table 1). Regarding CPI growth, the report noted "toward the end of the projection period, underlying CPI inflation is likely to increase gradually toward achieving the price stability target," but in the newly added projections for FY25, the median forecast for core CPI (excluding fresh food) is only +1.6%.

TABLE 1: OUTLOOK REPORT'S INFLATION FORECASTS

Raising USD/JPY point forecast on push back in forecast for timing of YCC end

Now that the BOJ has decided to keep policy on hold, looking back at Governor Ueda's remarks since his inaugural press conference, it seems clear in hindsight that he had been signalling that the Bank would not change policy at this meeting. I note that Governor Ueda has maintained close dialogue with the market, as had been requested by Prime Minister Kishida before he took office as governor. The abolishment or revision of YCC would have come as a surprise by its very nature, but even still, Ueda had repeatedly talked about postponing any policy changes at the meeting or attached conditions to any changes. This would make the next meeting in June a likely time for changes in monetary policy. Considering this, Ueda could continue to push out a dovish message suggesting that the Bank will keep policy on hold in June as well. Naturally, this is unlikely to kill off expectations for a change in monetary policy sometime in the future but fading expectations for a change in monetary policy in the second half of April resulted in the EUR/JPY temporarily hitting an eight-year high, pointing to the prospect of yen weakening led by cross-yen rates in the near term. I  had assumed that the BOJ would end YCC in April at the earliest, or if not, in June. I have revised our USD/JPY forecasts because I have pushed back our outlook for the timing of this. I made no change to my forecast range, which I think is reasonably wide, but revise up the forecasts for the end of each quarter by one yen.

QUARTERLY FORECAST RANGE AND PERIOD-END FORECAST

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