"Super Central Bank Week" is coming, but the main character is not the Federal Reserve?

The three most important central banks in the world are about to announce updates to their monetary policies. The Bank of England may cut borrowing costs on Thursday, while the Federal Reserve is likely to keep interest rates unchanged on Wednesday but may hint at a rate cut in September. However, the most crucial decision may come from the Bank of Japan.

Recent volatility in the US stock market, especially the significant sell-off in large tech stocks coinciding with the strengthening of the Japanese yen, has caught investors' attention. A theory quickly emerged: if the Bank of Japan is about to raise interest rates while the Federal Reserve is expected to cut rates soon due to recent weak inflation data, this would narrow the interest rate differential between the US and Japan, making the yen more attractive. As a result, investors who borrowed yen to buy US large tech stocks had to quickly reduce these positions to cope with the yen's strength.

This may be true, but there is currently no data or reliable evidence to prove it. Perhaps the correlation between the yen's strength and the decline in US large tech stocks is just a coincidence. Or the causality may be reversed, meaning that although the yen recently fell to its lowest level in 38 years, it still retains some safe-haven value and attracts buyers when US stocks fall.

Nevertheless, the correlation between the two is real, indicating that due to uncertainty in the market about the extent of tightening measures the Bank of Japan will take, the Bank of Japan's interest rate decision may become the primary driving force in the market this week.

Charu Chanana, Head of FX Strategy at Shengbao Bank, pointed out that for those concerned that the Bank of Japan may trigger broader market volatility, the good news is that the bank has "a long history of disappointing hawks."

Indeed, the Bank of Japan is likely to tighten monetary policy by reducing bond purchases. Chanana expects the Bank of Japan to announce a decrease in the monthly purchase amount of its 5 to 10-year bonds from 6 trillion yen (about $320 billion) to 5 trillion yen (about $270 billion), and further decrease to 3 trillion yen (about $195 billion) within two years.

However, traders are less certain whether the Bank of Japan will raise its main interest rate from the current 0.1%. The market is only pricing in about a 50% probability of a 15 basis point rate hike, which effectively means the market is betting on a 7-8 basis point rate hike by the Bank of Japan.

She believes the Bank of Japan is unlikely to implement both a rate hike and a significant reduction in bond purchases at the same time. Chanana said, "Taking two hawkish actions at a monetary policy meeting may be a bit excessive for a fundamentally dovish central bank."

Therefore, the impact of the meeting on the market may not be as significant as some people expect. Chanana believes that with the rapid appreciation of the yen last week, many policy changes may have already been absorbed by the market.

Chanana said, " Unless the risk of a US recession significantly increases or the Federal Reserve shifts to a more dovish stance, the likelihood of the yen continuing to appreciate and the yen/dollar exchange rate falling below 150 is not high." Chanana added that if the Bank of Japan does not meet the more hawkish expectations and shows a cautious attitude, "carry trades funded in yen may become popular again."

This is good news for Japan's Nikkei 225 index, which typically has an inverse relationship with the yen. Moreover, Japan's still cheap money supply is likely to support global stock market sentiment.