Industry Insight Spotlight on S&T

BOJ's Rate Hikes and its Impact on Sales and Trading 

Context

The Bank of Japan (BOJ) recently raised its benchmark interest rate from 0.25% to 0.50%, marking the highest increase in 17 years. This shift is particularly significant given Japan’s historical monetary policy stance, as the country has long been trapped in a deflationary cycle, maintaining ultra-low or negative interest rates to spur economic growth and avoid stagnation. This comes after the BOJ brought its interest rates from negative to positive.

Impact on the Markets

Unwinding of Carry Trades: The increase in Japanese interest rates diminishes the appeal of the yen as a funding currency for carry trades. As borrowing costs rise, traders who previously engaged in these strategies may unwind their positions, leading to increased volatility in currency markets. This shift could result in rapid appreciation of the yen, impacting global currency pairs and associated trading strategies.

Equity Markets strengthening: The yen strengthened by 1% against the British pound and also saw upward pressure against other major currencies. This appreciation is driven by higher domestic interest rates, which make yen-denominated assets more attractive to investors seeking risk-free returns. The Nikkei 225 and broader Topix index experienced selling pressure following the announcement, with financial stocks (banks, insurers) benefiting from higher rates while exporters and highly leveraged firms saw declines.

Fixed income trading: 

Bond Market Dynamics: The BOJ’s extensive bond-buying programs over the years have led to a significant portion of Japanese Government Bonds (JGBs) being held by the central bank. This concentration has resulted in reduced liquidity in the bond market. As the BOJ begins to unwind its balance sheet, traders may face challenges due to the scarcity of available bonds, complicating strategies that rely on bond availability and liquidity.

Futures Settlement Issues: The shortage of JGBs in the open market can interfere with the settlement of derivatives contracts, particularly futures. For instance, a specific 10-year JGB tranche, predominantly held by the BOJ, is set to become the benchmark for futures contracts. Its scarcity could lead to difficulties in fulfilling these contracts, affecting hedging strategies and market stability

Bank’s actions

Deutsche Bank: In May 2024, Deutsche Bank successfully issued ¥64.3 billion through a multi-tranche Euro-Yen bond issuance, marking its return to the Japanese yen market after nearly a decade. This strategic move aligned with growing investor appetite in a low-interest-rate environment, following the Bank of Japan’s policy adjustments. 

The end of Japan’s negative interest rate policy era signalled a broader shift towards economic normalisation, reinforcing confidence in yen-denominated assets. With expectations of economic growth and a potential yen appreciation, investors might have been more inclined to invest in such bonds, creating favourable conditions for issuers like Deutsche Bank.

Softbank: Following the Bank of Japan’s interest rate hike to 0.50%, SoftBank Corp. strategically issued Bond-Type Class Shares—a hybrid financial instrument combining features of both equity and debt. This move was influenced by the changing interest rate environment and aimed to strengthen SoftBank’s capital base while minimizing the impact on existing shareholders.

Amid rising borrowing costs, traditional debt financing became less attractive, making hybrid instruments a more cost-effective alternative. Bond-Type Class Shares, offering fixed dividends - 2.50% per annum for Series 1 and 3.20% per annum for Series 2- presented a cost-effective alternative. These rates were competitive, sitting between typical bond yields and common equity dividends, making them attractive to investors while providing SoftBank with favourable financing terms.

JPMC: They adjusted their carry trade position. JPMorgan has been actively involved in managing carry trade positions, which involve borrowing in low-yielding currencies like the yen to invest in higher-yielding assets. The BOJ’s rate hike has prompted a reassessment of these strategies, as the narrowing interest rate differentials reduce the profitability of such trades. JPMorgan’s analysts have highlighted the shifting dynamics of funding currencies and the implications for carry trades in light of recent monetary policy changes. For example, the bank highlights that while the yen has traditionally been a popular funding currency due to its low interest rates, recent policy shifts necessitate a reevaluation of its suitability thus executing less carry trades.