Buy rumours, sell facts ... but don't take a taxi

I had heard so much about Tokyo that I jumped at the first opportunity for a visit. My fascination with Japan is based partly on the yen, a currency that I have tracked closely, the Nikkei, an index the infamous Nick Leeson had traded and finally Japanese gardens.

When I finally landed in Tokyo what caught my fancy even more was that a taxi ride from Narita Airport to my hotel cost nearly $200 and that too in a country in a recession since 1990.

However last week saw a glimmer of hope that the economy had finally gained the long awaited traction it needed. The Bank of Japan (BoJ) ended a five-year old experiment with ultra-loose monetary policy and the decision represents a first step towards an eventual interest rate rise something that might appear unthinkable in Japan just as a $200 taxi ride may to some of us. Let us spend a moment understanding what has happened.

Interest rates in Japan are still close to zero the unsecured overnight call rate has been pinned at around 0.001 per cent for the last several years. However what has changed is the so called 'quantitative' easing policy, which involved flooding the banking system with excess funds.

Going forward

This policy was adopted provide liquidity to banks and prevent a credit crunch that could hurt an economy already grappling with deflation. Going forward, the BoJ will cut the cash provided to lenders to about 6trillion yen, down from the current 30-35trillion yen.

At a later stage, the Bank of Japan may decide to actually hike interest rates. Our house sees a rate rise by 25bps towards the end of this year. Given recent economic data and statements from various BoJ officials, the financial markets had been preparing themselves for a rate hike.

This expectation was largely responsible for the Dollar falling to 115.50 yen at the start of the year and yen swap rates zooming higher. The reaction leading up to, and after, the announcement has seen the yen weaken, the Nikkei rally and swap rates fall.

While this may not be the typical market reaction you would have expected, trading psychology leading up to a major event can often be summed up as "Buy the Rumour, Sell The Fact". Moreover, the BoJ has in reality not moved away from zero interest rates, they have just announced an end to a 'quantitative' easing policy.

Too hasty

Needless to say, any such decision is not easy to come by or make. In the past, the Bank of Japan has tightened monetary policy (August 2000) on the basis of a foreseeable economic recovery, only to be proved wrong later on. This time around, a word of caution has come from the government itself, with Prime Minister Koizumi cautioning the BoJ about being too hasty.

Whether the BoJ has got the timing right this time around, only time will tell. However what is clear from the first step taken last week is that BoJ Governor Fukui and others in the central bank are relatively confident of what they foresee.

The reality is that the BoJ is unlikely to be in a hurry to actually hike rates and their decision making, like the Fed and other central banks is likely to be driven by future economic data.

For now the reality remains that the 30 year bond yields just 2.30 per cent but an apartment could rent as high as $250,000 a year! Going forward, a lack of consistent data is likely to see gyrations in the FX, Equity and Bond markets and make life rather tough for those looking to hedge their exposures to these markets. After all, when it comes to the yen, the only place you are likely to find a "perfect" hedge is in a Japanese garden.

The author is Regional Head of Sales, HSBC Global Markets, Middle East. The views expressed herein are his own and not necessarily those of his employer.