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Interest Rate Hike Speculation Grows in Japan Amid Widening US-Japan Rate Gaps

BOJ's unexpected bond buying cut fuels speculation of a July rate hike, with investors predicting varying degrees of monetary tightening.

By Mackenzie Crow

5/15, 00:44 EDT

Key Takeaway

  • BOJ's unexpected bond buying cut fuels 70% speculation of a July rate hike, amid widening US-Japan interest rate gaps.
  • Japanese bond yields hit decade highs; Nomura predicts the 10-year yield could surpass 1%, with potential yen strengthening.
  • Diverse investor expectations on BOJ's future moves, with predictions ranging from limited tightening to multiple hikes reaching up to 1.5%.

Interest Rate Hike Speculation

Investors are increasingly betting on the Bank of Japan (BOJ) to raise its benchmark interest rate by July, with overnight indexed swaps indicating about a 70% likelihood of such a move, a significant increase from the 50% chance earlier this month. This speculation has been fueled by an unexpected reduction in the BOJ's bond buying during a regular operation, signaling a potential shift in monetary policy. The anticipation of a rate hike is partly due to the widening gap between Japan's low interest rates and higher borrowing costs in the US, exerting downward pressure on the yen. There's also speculation that the BOJ might announce a broader cut to bond buying at its June meeting, possibly setting the stage for a rate hike in July.

Market Movements and Predictions

The yen remained steady in Tokyo following these developments, while Japanese bond yields, particularly for 20-year and 30-year debt, have climbed to their highest in a decade. The benchmark 10-year yield is approaching 0.975%, the highest since 2013. Christopher Willcox, head of Nomura Holdings Inc.’s trading unit, suggested that the 10-year yield could exceed 1% due to persistent inflation. Despite these pressures, Willcox also mentioned the possibility of the yen strengthening to around 140 to the dollar this year, anticipating "limited tightening" by the BOJ, potentially in October.

Diverse Expectations Beyond July

Investors' outlooks vary regarding the BOJ's actions beyond July. Some market gauges indicate only one additional rate hike this year following the BOJ's move in March. However, firms like Pacific Investment Management Co. (Pimco) and Vanguard Group Inc. have more aggressive expectations, with Pimco foreseeing three more hikes and Vanguard's Ales Koutny predicting rates to reach around 0.75% by year-end. Goldman Sachs Group Inc. expects the BOJ to lift rates twice a year until they reach 1.25% to 1.5%. Opinions differ on the BOJ's approach to rate increases, with some investors cautioning that sharp hikes could lead companies accustomed to low borrowing costs to reduce spending, while others argue that failing to raise rates could further weaken the yen and inflate import costs.

Street Views

  • Christopher Willcox, Nomura Holdings Inc. (Neutral on Japan's interest rates and yen):

    "The 10-year yield can possibly get to exceed 1% at some point because inflation will likely remain elevated... the yen could still strengthen to as much as 140 to the dollar this year, with the expectation of the BOJ announcing 'limited tightening,' possibly in October."

  • Pacific Investment Management Co. (Bullish on Bank of Japan rate hikes):

    "Sees the prospect of three more moves this year."

  • Ales Koutny, Vanguard Group Inc. (Bullish on Bank of Japan rate hikes):

    "Expects hikes to around 0.75% by the end of the year."

  • Goldman Sachs Group Inc. (Bullish on Bank of Japan rate hikes):

    "Sees the BOJ lifting rates twice a year until they reach 1.25% to 1.5%."

  • Tadashi Matsukawa, PineBridge Investments Japan Co. (Neutral on Japanese bonds):

    "If the BOJ raises interest rates twice a year, the yield on medium-term bonds and especially five-year notes will be affected."