NEW YORK/SINGAPORE (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 toshake up its policy stance, one avenue would be to be lessaggressive in purchasing longer-dated assets, thereby allowingyields to go up, while cutting short-term rates deeper intonegative territory.
This would likely result in a rise in yields of U.S.Treasuries and other government bonds, and on the margin push uplong-term borrowing costs for consumers and corporations.
Japanese investors have poured money into foreign bonds in ascramble for income-generating assets as domestic bond yieldshave turned negative. This is contributing to holding globalyields near historically low levels.
"The BOJ is important in part because the Japanese have beenbuying anything abroad that gives them yields," said DavidKeeble, global head of interest rates strategy at CreditAgricole Corporate & Investment Bank in New York.
Last week, the yield on 10-year Japanese government debtrose close to zero percent, a level not seen since March, in aglobal bond market sell-off triggered by the European CentralBank's decision to refrain from expanding its asset purchaseprogram on Sept. 8.
The ECB's move intensified worries that major central banksare running out of tools to aid their economies.
"Japan has struck a chord in terms of the generalisedperception that there isn't that much left in that tank forpolicymakers from a monetary standpoint," said Charlie Diebel, head of rates at London-based asset manager Aviva Investors.
"Therefore, if you still need to provide stimulus, perhaps monetary policy isn't the way it is going to be forthcoming,"
The U.S. economy is far from robust, posting a sub-par 1.2percent increase in second quarter gross domestic product.However, Japan, the world's third-biggest economy, is strugglingeven more, eking out just 0.7 percent growth in the same period.
The BOJ will undertake a comprehensive review of its monetary policy at its Sept. 20-21 meeting, and there is 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 willconvene during the same period as their Japanese counterparts,are widely expected to leave their benchmark policy rateunchanged in a range of 0.25-0.50 percent. They will likely keepthe door open for a rate increase by year-end.
To be sure, if the Fed stuns investors by raising rateswithin hours of their Japanese counterparts' decision, thatwould overshadow anything coming from Tokyo.
The consensus is the Fed will keep its powder dry given therecent patch of soft economic data. Also, it may be reluctant toraise rates, and possibly upset financial markets, ahead of atightening presidential election on Nov. 8.
ONE FOOT OUT THE DOOR
Japan's struggle has persisted even as the BOJ adoptedunconventional measures of negative interest rates and massiveasset 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 and 13 percent versus the euro so far thisyear. Bond curves globally have meanwhile steepened, led by a rise in Japanese long-term yields, in the past couple of weeks.
"If you think about the last 15-20 years, we always thought Japan was the outlier. In fact, it turned out they were pretty much the leader," said Ashley Perrott, head of Asian fixed income at UBS Asset Management in Singapore.
"The rest of the world has followed the Japan path to lower yields. And I think they are still probably leading," he said.
The BOJ's ability to communicate its intent is therefore key, and some analysts even suspect the confusion heading into Wednesday's meeting is intentional, aimed at upsetting the single-bet mentality in the market and thus limit any fallout.
Interest rate markets implied traders expect a 17 percentchance the BOJ would lower its target rate to -0.30 percent onWednesday and a 14 percent chance the Fed would raise thefederal funds rate by a quarter point, according to Reutersdata.
Real money and leveraged investors are therefore playing it extremely safe. Perrott, whose team manages $3 billion in its Asian portfolios, has cut back on interest rate exposure, while still holding derivatives that will protect UBS should bond markets rally once again.
"It is a wild card and will definitely see markets move," Scott Mather, chief investment officer of U.S. Core Strategies and a managing director at the $1.5 trillion Pacific Investment Management Co (PIMCO), referring to the BOJ.
"We are relatively neutral on the government-bond market and we don’t have a large position to our risk exposure in Japan. Definitely, investors are coming up to the sense that the effect of monetary stimulus is not as advertised.”