FX Focus - CNYJPY: Relative value within Asian FX

Bank of Japan (BoJ) at its March meeting exited its negative interest rate policy (NIRP) and reset the Tokyo Overnight Average Rate (TONA) from -0.1% to between 0.0 and 0.1%. It also formally ended its yield curve control (YCC) policy and ended exchange-traded-fund (ETF) and Japan real estate investment trust (J-REIT) purchases that were part of its quantitative easing (QE) policy. These amounted to token adjustments. But what the BoJ did not do was to jettison the most substantive part of its QE program - buying of Japanese government bonds (JGB). Governor Ueda indicated the BoJ will retain its JGB buying (Rinban purchases) to the end of Q2’24 at close to recent operations and may conduct additional unscheduled JGB purchases if yields rose too rapidly. Markets interpreted this to be dovish and further weakened JPY that hit its lowest vs USD since the 1990s at 151.97.
 

But markets may have been too quick to jump the gun because the BoJ also dropped its inflation-overshooting commitment that requires it to expand Japan’s monetary base until the YoY change in core CPI exceeds 2% and stabilizes at that level. Governor Ueda also acknowledged the virtuous economic cycle is strengthening in Japan and indicated he wants to mull cutting bond buying at some point (after Q2’2024). These constituted the more hawkish elements of BoJ’s meeting but went unnoticed. However, these are significant because they indicate the BoJ has likely broken the shackles that committed it to its ultra-easing policy and if Japan’s macro nominal wage data for April and May show the YoY change in scheduled earnings exceeds 3% and is reflected in April and May CPI data, then the BoJ may well accelerate its pace of rate hikes as early as July and beyond.
 

Meanwhile, March 22nd saw USDCNH break above its YTD high of 7.2325 to trade up to 7.2795 (highest since Nov 14th) and representing one of the largest movements in a single day. This was due to 3 reasons – (1) PBOC’s daily CNY fix came at a 7.10 handle for the first time since March 7 (daily fixings had been slightly lower between 7.0930 – 7.0985 in the prior 2 weeks); (2) Onshore USDCNY traded above 7.20 for the first time since November and closed just shy of the upper-band of the 2% daily trading threshold vs. the fix (7.2424); and (3) apparent lack of USDCNY selling around the 4.30 PM CFETS (CNY basket) close (typically when RMB supportive intervention is seen). This was read as a subtle shift in policymakers’ stance towards RMB depreciation.
 

The Chinese economic recovery remains tepid at best and China’s policymakers have sought to lower interest rates but keep the currency stable by keeping the daily CNY fixings fairly constant (since last July) and linking future rate cuts to Fed cuts to keep rate differentials stable. With that said, the PBoC may have chosen to tacitly allow CNY to depreciate modestly and in an orderly manner as a way to aid the economic recovery without destabilizing capital flows. If true, then this makes CNY (or CNH) a better candidate to sell against JPY during Q2 for investors who are waiting patiently for the Yen to strengthen but unlikely to see much movement in G10 FX pairings vs JPY given their central banks (Fed, ECB, BoE etc) are not yet ready to ease financial conditions.