Just this afternoon! The interest rates in Japan are expected to enter the "1 era" for the first time in over 30 years?

The market widely expects that the Bank of Japan will raise its benchmark interest rate to the highest level since 1995 at a policy meeting today without the presence of the governor. According to a survey by industry media, almost all Bank of Japan watchers expect the central bank to raise its benchmark interest rate by 25 basis points to 1% at the end of the two-day meeting on Tuesday. The Bank of Japan had previously stated that Governor Haruhiko Kuroda had been hospitalized recently for the treatment of a liver cyst infection, and he would submit his opinions to the board in writing rather than participate in the vote in person. The expected rate hike by the Bank of Japan would be the first since December last year, coming as policymakers address the inflation risks brought by the Middle East conflict, even though the peace agreement is on the horizon. The market will closely monitor clues as to when the Bank of Japan may take further action, with traders concerned that if the yen weakens, Japanese authorities may intervene in the foreign exchange market after the meeting. Bank of Japan is expected to hike interest rates today The Bank of Japan has indicated that Deputy Governor Masayoshi Muto will replace the hospitalized Governor Kuroda today to explain the central bank's latest decisions and future policy direction. It is worth noting that Muto has just recovered from leukemia treatment. Investors will be watching to see if this senior central bank official will be more direct in his statements compared to Governor Kuroda in terms of the future rate hike path and the Bank of Japan's asset purchase policy. Muto has been widely regarded as one of the architects of the Bank of Japan's policy framework over the past two decades. Muto faces a delicate challenge: he must demonstrate a firm stance to stem the yen's decline, while also balancing the expansionary monetary policy favored by Prime Minister Naoto Kan. Some economists point out that if Muto's position does not align with Kuroda's, it could lead to significant market volatility. Chief economist at Daiwa Research Institute suggests that Muto is likely to use his rich experience in policy implementation to provide a meticulous and rigorous interpretation that will help market participants better understand the Bank of Japan's policy intentions, especially in interpreting the normalization process. Former head of the International Department at the Bank of Japan, Shigeto Nagai, stated that the Bank of Japan must avoid angering the government led by Naoto Kan, which is increasingly sensitive to the risks of premature policy normalization, while also convincing investors that the central bank is not falling behind the situation amidst escalating inflation risks and a weakening yen. At the April meeting, Kuroda faced three dissenting votes in favor of a rate hike, the biggest disagreement during his tenure as governor of the Bank of Japan. Since then, the two decision-makers who had taken a wait-and-see stance at the previous meeting have voiced support for a rate hike, and Kuroda hinted at the possibility of a rate hike in his final planned speech before the June meeting. Investors will also be watching for any dissenting voices among Bank of Japan officials against a rate hike. Toichiro Asada, the first policy board member nominated by Prime Minister Naoto Kan, may lean towards supporting a more accommodative policy - reflecting the prime minister's stance. One reason for the opposition to a rate hike in June is the weaker inflation data, currently below the Bank of Japan's target of 2% due to government subsidies. However, the Bank of Japan expects inflation to accelerate later this year as higher energy costs resulting from the Middle East conflict seep into the economy. Kuroda has hinted that the CPI growth rate may exceed 3% within this fiscal year. Another key focus of this meeting is the Bank of Japan's reduction in bond purchase program. Currently, the Bank is reducing its bond purchases by 200 billion yen per quarter until March next year. Concerns about a rapid exit causing disruption in the bond market led to halving the pace last year. Despite the reduction, after over a decade of massive asset purchases, the Bank of Japan still holds about half of Japan's outstanding government debt. The yield on Japan's 10-year government bonds reached its highest level since 1996 in May, highlighting the dramatic volatility in the Japanese bond market this year. Earlier this month, Kuroda stated that policymakers would consider improving market functioning and stability when planning future bond purchase programs. Sources also revealed that officials may discuss slowing down the pace of reduction or even pausing the process altogether as the bond market conditions improve. Will the yen arbitrage trading storm resurface? It is worth mentioning that the talk of a rate hike by the Bank of Japan may bring to mind the "global storm" caused by the unwinding of yen carry trades in August 2024 - at that time, the unwinding of carry trades sparked dramatic market volatility, with the Nikkei 225 index plummeting 12% in a single day and US stocks following suit. However, this time, the impact of the Bank of Japan's rate hike may not be as significant. The primary reason may be that the global monetary policy environment is now very different from two years ago. This time, the Bank of Japan's rate hike is not swimming against the tide. In 2024, the Bank of Japan's rate hike actually occurred amidst a global trend of easing monetary policy, with the Bank of Japan raising rates while the Federal Reserve was cutting them, leading to a significant clash. Currently, rate hikes in various countries are actually the trend. The Bank of Japan's decision to raise rates is simply to align itself with other central banks that are tightening policies, including the European Central Bank, which just raised rates last Thursday. Even if the policy rate is raised to 1%, Japan will still have one of the lowest rates among developed countries. Furthermore, market participants had been expecting the Bank of Japan's rate hike, and in a sense, many felt that the central bank's action was too delayed. This can be seen from the selling of the yen and Japanese bonds in the past few weeks. Unlike past concerns about unwinding of carry trades leading to a surge in the yen, many investors are now more anxious about whether the rate hike can still stop the current depreciation of the yen. Despite the record intervention by Japanese authorities to support the yen exchange rate, the yen is still hovering near the key threshold of 160 yen to the dollar, which prompted government intervention in the market when the exchange rate reached that level. For a resource-importing country like Japan, currency depreciation will exacerbate inflationary pressures. Foreign exchange market positioning data shows that speculative short positions on the yen have reached a nine-year high in recent weeks, indicating that despite the risks of intervention and a possible rate hike by the Bank of Japan, yen carry trade remains hot. Macro analyst Taro Kimura stated, "With major central banks raising rates one after another, interest rate differentials could once again become the main driver of yen weakness as seen in 2022, thus increasing the risk of upside inflation." Is the Bank of Japan's rate hike action too late? An interesting phenomenon is that many overseas investors are now starting to withdraw from the Japanese bond market, even after the yields on Japanese government bonds are finally high enough to attract global fund managers back to the market after more than a year. Institutions such as T. Rowe Price Group Inc., Schroders Global Group, and Brandywine Global Investment Management have recently reduced their investments in Japanese long-term bonds or hold only a small amount of such bonds. The latest data shows that in April, the amount of Japanese ultra-long-term government bonds sold by foreign investors exceeded the amount bought, the first time since 2024. This change reflects market concerns that even if the Bank of Japan is expected to raise rates on Tuesday, the pace of its monetary policy tightening may not be sufficient to curb inflation and stabilize the market. For many, the attractiveness of record high Japanese bond yields this year has been overshadowed by concerns about the Bank of Japan's slow response and susceptibility to political pressures. A report released by JPMorgan recently pointed out that the Bank of Japan's rate hike may not trigger a significant rally in the yen, and the effectiveness of intervention may be limited. JPMorgan noted that the market has already priced in a lot of expectations regarding the Bank of Japan's future rate hike path. To bring about a hawkish surprise, the central bank would need to clearly indicate a faster pace of rate hikes or even raise rates above the neutral rate, but this possibility is low. Meanwhile, if the central bank decides to slow down or even pause the reduction in bond purchases from April 2027, it may be interpreted as being dovish. Overall, there is a higher risk that the meeting's outcome will be seen as dovish, potentially triggering selling pressure on the yen. JPMorgan emphasized that the current environment is significantly different from the summer of 2024. At that time, both Japan's Finance Ministry intervention and the Bank of Japan's rate hike were unexpected, while weak US employment data pushed up expectations of a Federal Reserve rate cut, leading to a broad decline in the US dollar and ultimately triggering a massive unwinding of yen shorts, causing the dollar to fall more than 20 yen. In comparison, this time both the rate hike and intervention by the Bank of Japan have been partially priced in by the market, and after strong US employment data, the market has begun to factor in expectations of a Federal Reserve rate hike, providing broad support for the US dollar. This article is reproduced from "Caixin", written by Xiao Xiang; GMTEight editor: Feng Qiuyi.