The Bank of Japan (BOJ) has raised its benchmark interest rate and announced plans to reduce bond purchases, marking a significant shift toward monetary policy normalization. Japan’s central bank raised its policy rate to approximately 0.25%, from a range of 0 to 0.1%. This is the second rate hike by BoJ since 2007.
Simultaneously, the central bank expects its holdings of government bonds to decrease by 7% to 8% over the next two years. The amount is now planned to be cut by around 400 billion yen per quarter, which will take the total JGB holdings down by about 7% to 8% by fiscal 2026.
The BOJ’s JGB holdings stand at a whopping 579 trillion yen as of Jul 19, according to CNBC’s calculations. BoJ plans to decrease monthly bond purchases to around ¥3 trillion ($19.6 billion) by early 2026, down from the current pace, which is double that amount.
Governor Kazuo Ueda hinted at further rate hikes this year, contingent upon economic data and the impact of recent policy changes. The move is seen as a significant policy shift from the BOJ's previous stance of maintaining ultra-easy monetary measures.
Market Reaction
Following the announcement, markets experienced volatility, with stocks closing 1.5% higher, driven by gains in banking shares. The yen initially fluctuated but ultimately strengthened, reaching 152.12 against the dollar. Government bond yields also rose following the decision, with 10-year yields hitting 1.05% and two-year yields reaching a 15-year peak.
Impact on Global Markets
The BOJ's hawkish stance could influence currency dynamics, particularly against the backdrop of the Federal Reserve's upcoming meeting, which may give cues of monetary policy easing. Traders are watching for signals of a narrowing interest rate differential between the United States and Japan, which could further impact the yen's strength.
What Lies Ahead?
The BOJ maintained its inflation outlook, forecasting core inflation to remain around 2% through March 2027. However, since the BOJ's actions were not widely anticipated, market uncertainties are lingering, causing the yen and Japanese stocks to remain volatile. Analysts now speculate the possibility of additional rate hikes later this year, potentially in October or December, per a Bloomberg article.
ETFs in Focus
Japan Currency ETF to Gain
As the BoJ hikes rates, there are a few investing areas that could gain. First, any kind of monetary policy tightening is likely to benefit Invesco CurrencyShares Japanese Yen Trust FXY. The national currency, Japanese Yen, is also the currency of the accounts of the Bank of Japan. The fund was up 2.3% on Jul 31.
Un-Hedged Japan ETFs Should Be in Sweet Spot
Despite a recent rally, Japan ETFs are still cheap. Hence, we do not expect any rate hike to weigh on Japan ETFs. Instead, as BoJ hikes rates and the yen is likely to strengthen, investors may play non-currency-hedged Japan ETFs like iShares MSCI Japan ETF EWJ, JPMorgan BetaBuilders Japan ETF BBJP and Franklin FTSE Japan ETF FLJP.
Value ETFs to Gain
If the rates rise, value ETFs fare better than growth stocks. Hence, investors can tap iShares MSCI Japan Value ETF EWJV.
Will Small-Cap ETFs Fare Better?
In the face of a likely stronger yen, small-cap Japan stocks should do better than export-oriented, large-cap stocks. iShares MSCI Japan Small Cap ETF SCJ and WisdomTree Japan SmallCap Dividend Fund DFJ should thus be closely watched. However, before investing in small caps, investors should track the wage hike momentum. If wage hikes beat inflation (which will offer households purchasing power and companies can continue to pass on increased costs to consumers), small-cap Japan investing would be gainful.
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Get it free >>Invesco CurrencyShares Japanese Yen Trust (FXY): ETF Research Reports
iShares MSCI Japan ETF (EWJ): ETF Research Reports
WisdomTree Japan SmallCap Dividend ETF (DFJ): ETF Research Reports
iShares MSCI Japan Small-Cap ETF (SCJ): ETF Research Reports
Franklin FTSE Japan ETF (FLJP): ETF Research Reports
JPMorgan BetaBuilders Japan ETF (BBJP): ETF Research Reports
iShares MSCI Japan Value ETF (EWJV): ETF Research Reports
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