Volatility Besets Japan Equities as Negative Rates Verdict Still Out
OREANDA-NEWS. Japanese stocks gained for a second consecutive week as investors priced in a higher probability for a U.S. interest rate hike in June. The U.S. Federal Open Market Committee (FOMC) meeting minutes released last Wednesday, showed that the Federal Reserve will likely raise interest rates in June if economic data demonstrates stronger second-quarter growth as well as improved inflation and employment.
The view expressed by most of the Fed policymakers suggests that the central bank is much closer to lifting rates than the market expects. The implied odds of a June rate increased from nearly zero to 30% on Monday.
A rise in U.S. interest rates would lead to a weaker yen versus the dollar, positively impacting Japanese exporters’ profits. As of 23 May, the yen has depreciated 2.9% month-to-date against the dollar.
Correlation between yen movement and the Nikkei 225 Index has grown more positive since the start of the year. On Monday, 23 May, the 60-day correlation was 46.5%, more than double the year-to-date low of 19.9% which was recorded on 19 January 2016 when the collapse in oil prices roiled global equity markets.The yen’s swings are the largest amongst the G7 currencies, namely the euro, U.S. dollar, Canadian dollar, Pound sterling and the Japanese yen. On 13 May, the yen’s 30-day realised volatility reached 15%, its highest level in close to three years. In comparison, the maximum 30-day volatility for the other G7 currencies has not breached 13% this year.
The yen reached an 18-month high of 105.55 yen per dollar on 3 May, which prompted the Japanese Prime Minister Abe’s advisor, Koichi Hamada, to tell officials he would intervene if the yen firmed to between 90-95 per dollar, despite possible upsets from the U.S.. Japanese authorities last intervened in the currency markets in 2011, when they sold yen for dollars to stem a speculative spike in the yen.
The G7 gathering last week highlighted differences between Japanese and U.S. currency policy, with U.S. representatives suggesting that Japan has no justification to intervene in the market to stem yen gains as currency movements remain “orderly”.
The lack of consensus did not stop Japanese Finance Minister Taro Aso from issuing verbal warnings to markets against excessively pushing up the yen. "I told (Lew) that recent currency moves were one-sided and speculative," Aso said in a news conference on Saturday, adding that the yen's gains in the past few weeks have been disorderly.
Fluctuations in the yen price have corresponded to swings in the Japanese equity market, as seen from the elevated implied volatility of the Nikkei 225 Index. For the month up to 23 May, the average implied volatility for Nikkei 225 Index was 24%, higher than the key markets including S&P 500 Index (13%), EuroStoxx 50 Index (22%), Hang Seng Index (19%), KOSPI 200 Index (11%).Four months after the Bank of Japan (BOJ) surprised markets by adopting a negative interest rate policy, the verdict is certainly still out on whether the policy will bolster the economy and time may still be needed to see the full market impact.
Japan is not alone in experimenting with the unconventional negative interest rate policy. A number of European central banks have ventured into negative rates territory in the past few years, including Denmark, Switzerland, Sweden and the European Central Bank. The timeline below provides an overview of the trend and motives of these central banks implementing negative rates.The BOJ held off on expanding monetary stimulus in the March and April meetings as Governor Haruhiko Kuroda opted to take more time to evaluate the impact of negative interest rates on the economy. Policymakers are hoping that by bringing down borrowing costs with the 0.1% negative rate on a portion of bank cash balances at the BOJ, lending will accelerate and boost growth and inflation.
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With U.S. Federal Reserve officials talking up the possibility of a June rate increase, the yen and therefore the Nikkei 225 Index may be in for a turbulent summer. Analysts expect that a 1% increase in the U.S. benchmark interest rate would push the dollar into a significant rally.
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