Last night the BOJ left the yield curve control (YCC) in place which gave a temporary
shock to the markets, as USDJPY rallied from 128 to 131.50. Yen bulls that were
speculating on a change were surprised. Surely stop/losses were triggered.
For those that don’t follow FX very much, that is a massive move in one day. However, as
I write this 10 hours later, USDJPY has recovered the entire amount. This is even more of a surprise. After all, traders did not get the news they wanted. I am still not sure the all-clear has sounded on the Yen trade, as it was locals who were buying Yen before the BOJ and foreigners who were selling it, so the price action by time zone is still indicative of all parties closing out their positions.
However, as I talk to all of my students, we cannot ignore the price action, the reaction
to the news by various pools of capital. On net, the Yen strengthening trend has not been broken. What could this mean for other assets? In the first chart, I show you the tight coupling between the Yen and 10-year US Treasury yields. If the BOJ YCC stays in place and yields are fixed at a lower level, the surplus capital in Japan may very well look for higher yields and find
those in US Treasuries. With the currency again strengthening, those investors will have more buying power to buy up the supply forthcoming from the US government. Another big move overnight was in the 10-year yield as it fell 11 bps and is back below 3.5%
Falling 10-year yields will affect the prices of many assets. However, maybe most
importantly for the economy right now, it will affect the rate on the average 30-year mortgage for home buyers. You can see each of these on the chart here. What is a bit harder to see is the spread between the two rates which, due to QT largely, moved to over 3% spread. This spread is historically about 1.75% at least in the last 10 years. Let’s say it moves back to 2%. If the 10-year yield falls to 3%, could we soon be looking at 5% 30-year fixed? While not the 3%
outlier that we saw in Covid, a 5% mortgage is affordable. At the margin, more than a 2% move from the 2022 peak would attract buyers.
This last graph is the graph of the 30-year mortgage vs. the NAHB home buyer index
(inverted). As this index was plummeting, due largely to higher mortgage rates, traders called for the crash of housing this year. You can see the fit between the two so there is logic there. However, if mortgage rates are back near 5%, and the NAHB index moves up to 55 or so, right as we hit the spring selling season in the northern part of the US, would the narrative on housing shift? Housing does lead the economy into and out of recession after all.
As I have mentioned before, I think the odds of a soft landing are small. We have not
seen it occur many times in history (3 times out of 14 hiking cycles). If anything, this rate hiking cycle is more extreme than all of those. It would seem the odds should be lower and not higher in this case. However, I always try to avoid cognitive dissonance. I seek out information that conflicts with my theory and assess how plausible that could be. While I still contend the
bond market is too dovish and JayPo will look to change minds in the coming weeks, I can’t ignore the possibility that 10-year yields could continue to fall and bring mortgage rates down with it. This in turn could help support the housing market at a critical time. Housing leads the economy. Just as we are going into a recession, we might see the knight in shining armor to save us. This is far from my base case. However, t is a possible scenario that I must