(Bloomberg) — Bank of Japan Governor Kazuo Ueda had a clear message last week — the weak yen was a risk and rates were likely to keep rising.
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The reaction from traders to Ueda’s apparent hawkish turn was severe. The currency surged more than 3% against the dollar, and Japanese stocks had their biggest rout since 1987. In response, his deputy Shinichi Uchida delivered a fresh message this week — rate hikes were off the table so long as markets were in turmoil.
That had the desired response of paring some of the yen’s sharp gains and helping to calm markets. But it also left investors puzzling over how much faith to put in the BOJ’s comments and underscored how difficult it is for the central bank to limit market shocks as it unwinds years of extraordinary monetary stimulus.
“The mixed BOJ communications will only spook more volatility,” said Charu Chanana, head of currency strategy at Saxo Markets. “If only they keep their communication aligned, at least that may spare them from panic moves and unnecessary volatility both in yen and equities.”
The summary of opinions from the bank’s July meeting showed some of the nine board members emphasizing that monetary policy would stay accommodative. Nevertheless, the possibility of higher rates in Japan devastated the carry trade in which investors borrow in low-rate currencies and put the money to work markets with higher returns. Three-quarters of the global carry trade has now been removed, according to JPMorgan Chase & Co.
Uchida said his views were not at odds with his boss. The extreme market swings following the bank’s decision had created a different environment than during its policy meeting. The bank still intends to consider raising rates once markets have calmed sufficiently, according to Uchida. That explanation did not satisfy some overseas investors.
“Communication consistently needs to be clearer, more straight forward,” said James Malcolm, a London-based macro strategist at UBS. “Global investors just do not have the time or inclination or background to understand the nuances of the BOJ communication.”
Uchida’s comments were “damage control from the BOJ,” according to Carol Kong, a currency strategist at Commonwealth Bank of Australia.
“Recent market turbulence serves as a reminder to the BOJ that both their actions and words can have great ramifications given the huge positioning in the yen,” she said.
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Overnight index swaps data are pricing in a 31% chance of a 25 basis-point rate hike by the end of the year as of Friday morning, compared to more than 60% at the timing of the meeting last week. While the recent market upheaval may cause a delay, it likely won’t stop the central bank from raising the rate again, according to Hideo Kumano, an economist at Dai-Ichi Life Research Institute and a former BOJ official.
“Once the markets settle down, the BOJ will gradually signal the next hike to the market,” Kumano said. “I believe that the BOJ will be more careful in its communication, so the timing of the next rate hike will probably be pushed back.”
Other traders have sympathy for Ueda’s position. Inflation has been running higher than the bank’s target of 2%, partly driven by the weak yen. Raising rates was a clear way to buoy the currency and the impact on traders is not part of the bank’s mandate.
“Although there’s a sense of haphazardness in the BOJ’s communication, they couldn’t have anticipated market volatility to this extent,” said Yukio Ishizuki, a senior currency market strategist at Daiwa Securities in Tokyo. “Ueda was determined to correct the yen’s weakness, so I think the timing of the meeting was inevitable.”
Moreover, central banks often grapple with the challenge of clear messaging as market expectations can diverge from the central bank’s actual intentions, leading to misinterpretations of official statements or policy signals. Bets on US rate cuts, for instance, have swung wildly this year on fluctuating data and cautious messaging from Federal Reserve officials.
“What the BOJ is saying itself has not changed that much, but markets are overreacting to the tone and what parts are getting attention,” said Harumi Taguchi, principal economist at S&P Global Market Intelligence. “Communication is very difficult.”
–With assistance from Daisuke Sakai.
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