Don't Underestimate Japan

Lost in the shuffle of NFLX earnings and Trump's first few days in office for his second terms with endless headlines and sound bites is the Bank of Japan meeting this evening. Markets are actually almost fully pricing in a rate hike, the likes of which we have not seen since last summer when we saw a violent but ephemeral spike in the VIX as equities sold off and quickly recovered. Upon a rate hike tonight, rates would be at highs not seen since the 2008 crisis. 

The relevant issue for us, however, is whether the Bank of Japan signals future rate hikes at a fast pace...or not. In other words, there are tons of similarities to how markets read into a BoJ meeting as it does The Fed insofar as the focus being on the central banker's attitude and tone for future moves. 

A hawkish Bank of Japan likely sees the Yen currency strengthen, which pressures the "Yen Carry Trade," where traders had borrowed a cheap Yen and speculated aggressively around the world on risk assets. Last summer's fireworks were due, in part, to this unraveling. But the Bank of Japan backed off the rest of 2024 after getting initially scared of the market result. Another theory is that the Bank of Japan was heavily politically influenced or even intimidated by then-Treasury Secretary Janet Yellen to wait until after the inauguration to raise rates again. Of course, it is just a rumor and we have no way of knowing. 

Either way, what matters most is whether the head of the BoJ, Governor Kazuo Ueda, is now committed to fighting inflation in the land of the rising sun.

Japan's inflation rate is significantly higher than its 0.25% overnight rate, which means the BoJ embarking on a series of hikes for that overnight rate seems more likely now than ever.