Daily Update: October 7, 2024

Japan's central bank ended eight years of negative interest rates in March, raising its short-term policy rate to a range of 0%-0.1%. Now, at 0.25%, the rate is the highest it’s been since 2008.

As the Bank of Japan moves toward policy normalization, the country's three megabanks — Mitsubishi UFJ Financial Group (MUFG), Mizuho Financial Group and Sumitomo Mitsui Financial Group (SMFG) — are anticipating record net income for the fiscal year that started April 1. The banks forecast earnings to grow at double-digit levels as rising interest rates are expected to support domestic net interest margins, mitigating the impact of lower rates abroad.

MUFG, Mizuho and SMFG are poised to benefit from the tailwind, having already taken steps to address risks stemming from persistently high US interest rates and rising rates at home, according to an S&P Global Ratings report in June.

For one, Japan's megabanks boosted holdings of foreign bonds in 2023, including US Treasurys, and are expected to continue doing so amid lower US interest rates. The gradual increase of rates in Japan would continue to make US Treasurys appealing to Japanese banks, and a narrower gap between US and Japanese policy rates would lower the cost of hedging foreign exchange risk for Japanese investors, according to an S&P Global Market Intelligence report in May.

Toyoki Sameshima, a senior analyst at SBI Securities, told S&P Global Market Intelligence in September that declining US rates would reduce unrealized losses in the overseas bond portfolios of Japan's megabanks. While megabanks typically aim for capital gains from rising bond prices through trading, regional banks appear to prefer income gains from higher coupon rates by holding bonds until maturity, Sameshima said.

The megabanks also moved to shorten the duration of Japanese government bonds. "As for foreign bonds, the groups have reduced risk volume in past years. We think they have managed risk prudently with regard to foreign bonds because the timing and speed of the decline in US interest rates remain uncertain," according to S&P Global Ratings.

MUFG, Mizuho and SMFG are likely on track to report strong earnings gains for the current fiscal year, having already achieved over one-third of their full-year net income targets during the fiscal first quarter ended June 30. Mizuho posted a year-over-year increase of 17.9% in net income to￥289.3 billion, which is 38% of its full-year target of ￥750 billion. SMFG reported a 49.6% rise in year-over-year earnings to ￥371.4 billion, which is 35% of its projected net income of ￥1.06 trillion for the year. MUFG, despite a 0.4% year-over-year dip in net income to ￥555.8 billion, still attained 37% of its ￥1.95 trillion projected annual earnings.

Still, it's not all smooth sailing for Japan's megabanks.

The US Federal Reserve's recent rate cut, which lowered the federal funds rate by 50 basis points to a range of 4.75%-5%, may create headwinds that could trim overseas loan spreads. All three megabanks have ventured into overseas markets, particularly in the US and Asia, to boost their investment banking and financing businesses as Japan's negative rate policy diminished their interest in domestic lending.

Additional rate cuts by the Fed could also strengthen the yen against the US dollar and ease inflationary pressure in Japan. This could slow possible rate hikes by the Bank of Japan and create challenges for the megabanks' plans to raise lending rates at home.

Market volatility could also cause the pace of monetary policy normalization in Japan to decelerate. Shinichi Uchida, the Bank of Japan's deputy governor, said in an Aug. 7 speech to business leaders that the central bank will not raise its policy interest rate when financial and capital markets are unstable.

Uchida's statement came after the Bank of Japan's "double dose of monetary tightening" on July 31, which caused fluctuations in global markets due to concerns that the popular carry trade in the yen would unravel as the Japanese currency strengthens. Specifically, the central bank raised its benchmark short-term rate to 0.25% and proceeded with its plan to reduce its purchases of Japanese government bonds.

Today is Monday, October 7, 2024, and here is today’s essential intelligence.