Global Rates & FX Views: The great central bank review

Hello and welcome to Global Research Unlocked, the Interest rate NFX series. This podcast is based on our weekly client conference call where our strategists along with guests from other parts of B of A global research discuss the most topical and pressing questions face-by-our market. I'm Ralph Prosser, Head of Global G10 Rates NFX Strategy. Today is Friday, 18th of September. I'm joined today by Dr Sympa, Head of G10 Rates Strategy, Agnes Tenga Rates from Nuclear Rates Strategy, Megan Sviber from US Rates and Yamashita Sun from Japan Rates. Thank you all for joining and making yourself available. Yamashita Sun, let's start with you. How do you interpret the rates after the reaction that we had to the back of Japan today? OK, thank you everyone for joining the call. As expected, the B of A Rates is porcelain by 25B to 1.25%. Where the hype itself had been fully applied in the two deepening boards from Davish Board members. Asada and Sato both appointed under the TAKAichi-adomitilation. High-ten market speculation about potential political pressure on the B of A from Prime Minister TAKAichi. But after the statement was released, the market gave back expectations for an October 8 hike. And the 230JV curve street steepened. That said, governor would put a conference that was not too bad, Abish. In our view, a 50-bit hike at a single-needing or back-to-backed rate hike was never a particularly prolonged possibility. We just said that such a scenario would likely require either a significant information shock or blowing concerns that the B of J was falling behind the curve, similar to a track on the stance that pumped aggressive tightening by the Fed and ECB in 2022 and 2020's lead. Therefore, I will be agree with the market-ly action. Markets have largely applied out an October hike with the implied probability falling to around 18%. What expectations have shifted toward a December move? We remain comfortable with our baseline call for a further 25-bit late hike at the December meeting. Back to you. Thank you. We also had some announcements on liquidity. How should we think about that? Yes, let me also briefly touch on the changes to the climate-related fund-supplying operations. In our view, these changes are unlikely to have a meaningful market impact in the near-term, but they could become more important for a longer-term policy perspective. As the September meeting, the B of J provides its fund-supplying operations to support financing for climate-changing lift conferences, the changes include a new method for calculating the long-late and the introduction of caps on the amount of lending available under the program. Specifically, the long rate will no longer be the IOEL prevailing at the time the long is extended. Instead, it will be based on the average IOEL over the period during which the long-laming outbounding thus said the immediate impact is likely to be limited. In the most recent operations conducted in July 2026, loans under this operation amounted to roughly 14.000 yen, while outstanding loans stood at around 25 to leave in yen. Thus, the new caps are not binding at present and are unlikely to lead to a near-term reduction in the size of the B of J's balance sheet. Rather, we see these measures are laying the groundwork for a gradual reduction in liquidity provision as the B of J continues its balance sheet normalization process. In that sense, the change can be built as another implemented step toward normalization. Looking further ahead, we continue to expect the B of J's balance sheet to shrink as one of the fastest cases among major central banks ongoing QT together with the larger run-off of the fund provisioning measure to stimulate bank lending. It is like ECB teletolo should continue to deliver the normalization process over the coming year back to you. Thank you, Mr. Tusson. The use maintained a constructive stance on the long end of the JDB curve for the last few weeks. How much of that is about your faith in the B of J and how much is about your views on issuance? Sure. Our constructive view on the long end is derived primarily by improving supply-demand dynamics rather than build the liquidity. Why we recognize that concerns about the B of J are falling behind the curve are rising amid the growing political pressure from the TAKAichi administration. We continue to achieve several supportive factors for the long end of the JGB curve. First, news flow along large embassies, particularly major pension funds, has been supportive of sentiment toward the end duration. Second, our estimates suggest that net JGB supply relative to nominal GDP will decline in 2027 compared with 2026. Rosalie reflecting lower redemption of JGB held by the B of J. Third, we continue to see growth of deep-biting demand in the long end, particularly from non-Japanese investors. Taking together, we believe these supportive supply-demand factors outweigh the risk associated with the behind-the-carbon narrative thus we continue to maintain a conflictive and a conflictive and boosted by a strong toward long end JGB back to you. Thank you very much. Let's stick with the B of J. How should we think about the FX market reaction post meeting? Thanks, Charles. The FX reaction I would argue was much bigger than the rates move implied. So if I think about it, the B of J, where those press conference was pretty balanced, Yamashita discussed the changes in the rates market, but ultimately B of J price saying six months to one year out did not change that much and the long end was fairly well behaved. So what that tells me is the outsized DNS sell-off that we saw was ultimately all about FX policy credibility. And it's important because we have been constructive on the end for a variety of reasons, but one of the reasons has been our assumption that the various stakeholders on the exchange rate, the Bank of Japan, the Ministry of Finance, Takaichi, as well as the US Treasury, are aligned in terms of delivering what is needed from a policy perspective to stabilize the end. So the defense by Takaichi appointees was important because it does challenge that assumption to some extent. And I think that's the way the FX market saw it. And that's why the YEN sold off so much more than the rates market move would have implied. But I'd also argue that it doesn't invalidate the assumption just yet because ultimately the B of J, we do expect more policy steps to follow not just on monetary policy, but other measures as well. And as I said, there are other reasons why we are constructive on the end. But make no mistake about it. I think near-term FX credibility has taken a bit of a hit. And I think from an investor standpoint, there will certainly be less appetite in the near-term to bleed carry to belong the YEN in the interim. Now, the fun bit about your asset classes, but it's never about one side because in which it's two thirds to use the equation. So how much do you think the Fed matters when the YEN reaction that we had given that it's on the field for the next few weeks? Yeah, Ralph, I mean, traditionally, people always like to say the Fed matters a lot more than the local central bank. And especially in the case of Dolly Yen, it's said quite often. However, if you look at the price action, we've had a bigger move in Dolly Yen after the B of J meeting than we did after the Fed meetings. So I think the B of J is important for the reasons that I mentioned. But, of course, the Fed is important. And I think the fact that the Fed raised the hawkish bar, if you will, on Wednesday, obviously made it a bit more challenging for the Bank of Japan and for front-end pricing to kind of match those expectations. So I think the Fed is important. That's the dollar has strengthened broadly. Of course, and I'm sure Megan will talk about this. We expect front-end rates to move in the U.S. The question I've been getting is This is the Fed hawkishness sufficient for the dollar to reach new highs. And I think that will prove a bit more challenging only because, yes, the Fed is hawkish, but so are the central banks. And when I look at US growth divergences versus the rest of the world, things stand out less than they did say over the summer when the dollar did strengthen, but it never really broke out of its range. So the Fed is important, but I don't see enough here yet to suggest that we're going to break to new highs in the dollar, let's say, the euro or the DXY basket. Thanks so much for that. So Megan, let's stick with the Fed. What was your main takeaway for the Fed's market? Main takeaway, Ralph, is that worse things that policy rates are not restrictive. And he really rejected any academic definition of where neutralists. All we know is that he's on this path defined restrictive and is going to be likely relying on the market to tell him where that restrictive policy rate is. What really stood out to me is that he framed the hike as removing accommodation rather than tightening policy. And in general, a Fed that's using the market to tell it where restrictive is, is really going to be looking at financial conditions. We look at what really drives financial conditions at the end of the day. It's the equity market. And with equities pretty much unfazed by the market pricing about an additional 80 basis points of hike from here, we think that there's just more work that the Fed has to do. Thank you very much. So what are your duration and curve views after the Fed? We think that there's more room for front-end rates to move higher, and we think that there's more room for the curve to flatten. You can go through a few different frameworks to try to assess what policy rate the Fed is going to have to get to here. We talked about this in our weekly, we also had a nice note out this morning going through this. What we look at is Taylor Rule. You think the updated R star from the September FEP and FEP projections. You can use where real policy rates sit right now versus the unemployment rate. Also just looking at the FCP gives us some nice information on this in terms of how the committee, or I should say FOMC participants, that large are thinking about distribution of the round unemployment and inflation. All of the focus right now is on inflation, and you can use these frameworks to look back in time and sense where the Fed should be setting policy rates, and all three of these frameworks tell you that they're headed to a policy rate that's above 5%. Importantly though, this pass through to longer term rates, we think is going to be more limited. I just did some work on this in the weekly too. If you look at the beta that we see between where the markets assessing Fed funds go over the next 12 months, and the 10 year that beta tends to historically be pretty low and historically low when the Fed is hiking, much lower than when the Fed is cutting rates or when the Fed is on-sold. We do think that this supports more of a flattening view on the yield curve. I think that's especially true if the Fed is looking to financial conditions to tighten the pellet where restrictive is. Right now, we also see in a lot of our positioning work that the markets short duration right now, quite heavily underweight duration versus red product. So positioning also supports that if we do get more pressure on risk assets from a Fed that's committing on this pass, that there's going to be less pass through to the long end of the curve. So we like the flatness here as well. Great. Thank you. Arganist. Bank of England. Same starter question for you. What matters for the market? Hi, Ralph. So what mattered for the front end was the balance and bank of England's phone at the meeting, given their fairly explicit guidance in July that the bank were not edging towards a hike, so a repeat of that rhetoric as in July would have come across a stone desk now. It was reassuring to hear the viewers sounding more decisively hawkish compared to their tone in July yesterday. And the NPCs certainly signaled that they are looking closer to moving towards a hike. If recent rise in energy prices sustained and also barring big downside data surprises, but equally as importantly, the NPC also implicitly pushed back slightly against the market pricing of around four hikes, saying that some of it reflected risk premium and Bayley also highlighted that they didn't discuss the prospect of raising rates for time. So overall, the buoys on the tree assuringly hawkish and this hawkish hold resulted in slightly lower yields in the NPC data, Sonya contracts indicating that this communication challenge was successful for the bank. And then the second point of interest for the market was the QT vote. The banks over how of the QT sale process was not fully expected and turned out to be the big market mover on the day with long and yield rallying over 10 basis points and also outperforming Sonya by a few basis points. And so the announcement of the station of QT market operations although not QT altogether was essentially taken well by the market given the rally and bullishly for the long end as well. Great. Many thanks. How should we think about the QT announcement that you will be touched on? Yes. So we're still waiting on some operational details on how this new New Zealand file QT will work. But overall, we got a slower pace, which was expected, but with potentially some more support for a guild than would have been the case under state of school. So in particular, what should support guilds would be the likely absence of active guild sales for the next six months while the bank and the treasury iron out the technicalities of this new style of QT and also the perception that this new approach with the demon control of the supply way that average maturity would be more effective in limiting the impact of QT on guild term premia, essentially it's better to have one arm of the state selling guilds than two and responsibility for the structure of that profile should rest with the that management office. But an important thing to stress is that the net value of guilds to be absorbed by the market from active sales will be the same. We will get an extra 20 billion guild sales from the DMO rather than 20 billion from the bank, so the strong bull flattening on the news yesterday really represented rethink this market expectation of six month pause before active sales resume and also the view that additional sales from the DMO will be perhaps a bit shorter maturity than they would have been the case if the bank continued with the way they did QT so far. So again, if you look at it optically, Ralph, if you look at cable, it's actually the opposite of what I said for Japan, so the sell-off in cable after the FMC was larger than the sell-off that we saw after the bank of England. So optically you could say the Fed was perhaps more important than the bank of England, but I think the reaction to the bank of England decision was interesting. It seemed to me that the FX market was very much focused on the drop in front end rates and that's why still we can not just against the dollar but against a trade-weighted basket. But in some sense, the FX market didn't respond to the guilt market reaction, as Agner was saying, the UK guilt market took the direct to DMO QT sales quite well and usually when the curve flattens particularly for a country like UK where we're always fixated on fiscal risk, sterling tends to benefit and that didn't happen yesterday. So in our view, I mean lower guilt term premium over time does matter and therefore we don't know the counter-sactual, maybe sterling would have been a lot weaker in the absence of this QT announcement, but we do think ultimately this is a good thing over the medium term for the pound and we do think sterling should outperform particularly versus a currency like the euro that faces similar challenges in terms of potentially hiking rates in response to supply shock. Great, thank you Adash. Thanks for joining us today. We hope you found this useful and that you'll tune in next week. 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