Oftentimes, big market surprises reverberate for days and even weeks but BMO fixed income strategists view the Bank of Japan move to widen the yield-curve control band as more of an incremental change that's already been digested, at least in the US Treasury market.
"As for any further follow-through from the BoJ’s holiday surprise, our take is that the prospects are limited," writes the BMO team. "The repricing in JGBs has largely run its course and even if there are another 5-10 bps left of 10-year JGBs to test the upper bound of the expanded bands, the carryover into US rates will quickly diminish as investors settle into the reality that the BoJ is finally (but slowly) conforming to the hawkish bias of the other major global central banks."
USD/JPY fell as low as 132.00 but has rebounded to 132.447, down nearly 450 pips on the day. BMO sees Japanese buyers returning to the Treasury market, capping US yields.
"Let us not forget that the strength of the yen will not only be a welcome development in Tokyo, but it also marks a potential pivot for the hedging costs for Japanese investors looking to buy Treasuries and hedge the returns back into local currency. A move that is sufficient to bring in sidelined buyers has yet to be achieved; although the momentum has clearly shifted in a direction that will ultimately be favorable for Treasuries. The Fed’s arrival at terminal will also carry with it a collective sense of near-term policy stability that should encourage investors to reenter the Treasury market – at least from the perspective that the uncertainty associated with how far Powell would need to hike will be resolved. Recall that 2022 was the year of the revision (terminal estimate and otherwise); once the FOMC reaches the endpoint, policy rate vol will decline as Powell attempts to hold the restrictive line, as it were."
The path they outline could continue to weigh on USD/JPY as Treasury yields turn back lower. That's particularly true if the BOJ further normalizes policy.
Finally, it will be difficult for market participants to hold yen shorts in the coming weeks with a monthly threat of BOJ rug pull.
