MNI INTERVIEW: Yen Action Ups Case For Sept Hike: Yamamoto

Concerted U.S.-Japan intervention to support the yen would bolster the case for a Bank of Japan rate hike in September by easing political and public opposition to further policy tightening, former BOJ Executive Director Kenzo Yamamoto told MNI.

"It is natural that markets expect the BOJ to raise the policy rate in September, judging from recent developments," said Yamamoto, head of KY Initiative, citing the joint yen-buying intervention and comments by U.S. Treasury Secretary Scott Bessent.

The BOJ has been waiting for an opportunity to raise rates with broad support, including from the government, Yamamoto noted. "When the BOJ could not or did not want to raise rates, it argued that underlying CPI inflation had not yet reached the 2% target. Now markets are worried about the risk of the BOJ falling behind the curve, allowing the Bank to raise rates without attracting criticism."

Traders now see a 62% chance of a hike at the September meeting, up more than 10 percentage points since Monday.

YEN IMPACT

Downward pressure on the yen has eased somewhat following the joint intervention and Bessent's remarks that the U.S. "will not hesitate to participate in further joint intervention." Japanese Finance Minister Satsuki Katayama said Monday's action, which helped lift the yen about 3.2% against the dollar over the week to around JPY157.5, was aimed at countering "excessive volatility and disorderly movements" in the currency and pledged the government would not hesitate to take further action.

Yamamoto questioned the government's argument that recent dollar/yen moves had diverged from economic fundamentals. "If the exchange rate were truly far from fundamentals, intervention alone would trigger a sharp reversal," he said. Narrowing the U.S.-Japan interest-rate differential alone would not produce a sustained appreciation in the yen, Yamamoto argued. 

"As long as the interest-rate gap remains wide, selling pressure on the yen will continue. In addition, the government's bias toward expansionary fiscal spending without clearly identifying funding sources has undermined confidence in fiscal discipline and contributed to yen weakness."

Yamamoto has warned since May that the BOJ has fallen behind the curve and called for a series of gradual rate hikes. (See MNI INTERVIEW: Ex-BOJ's Yamamoto Urges Gradual Hikes)

JGB PURCHASES

Yamamoto also criticised the BOJ's decision to suspend reductions in Japanese government bond purchases from April 2027 and maintain monthly purchases at around JPY2 trillion, saying markets viewed the move as weakening the Bank's commitment to balance-sheet normalisation.

"The BOJ has repeatedly argued that JGB purchases are part of monetary easing rather than government financing. If that is true, returning its JGB holdings closer to pre-easing levels should be the benchmark for judging that claim."

Yamamoto said that the BOJ needs to demonstrate more clearly that JGB purchases were not intended to finance government spending, estimating the BOJ's holdings of long-term JGBs would still total about JPY217 trillion in fiscal 2040, well above the roughly JPY100 trillion held before the launch of unprecedented monetary easing in 2013. The BOJ's massive asset purchases had enabled the government to issue debt well beyond what the market would otherwise have absorbed, effectively financing fiscal expansion, he argued.

Yamamoto also warned that the BOJ's June decision was so vague that it would struggle to resume reducing JGB purchases in the future. (See MNI BOJ WATCH: Uchida Flags More Hikes; No Timing Hint) Should long-term interest rates rise sharply, he said, the government could increase pressure on the BOJ to expand its bond purchases again.

MNI: Advisors See New Bond Quotas To Bolster China Growth

Chinese fiscal authorities are likely to introduce additional government bond quotas in the second half to support consumption and investment as as local governments' debt-resolution efforts continue to absorb funds, policy advisors told MNI, adding guarantees and interest subsidies will play a larger role in supporting priority sectors and fiscal-monetary coordination.

The central government is expected to issue at least CNY500 billion of additional treasury bonds in H2, either by raising the fiscal deficit or issuing more special treasury bonds, an advisor to fiscal authorities told MNI, with the Standing Committee of the National People's Congress likely to approve the issuance in September. Beijing could also reactivate about CNY500 billion of unused local government special-purpose bond quotas if economic conditions deteriorate further, the advisor added.

With investment and consumption both weakening in Q2, GDP growth slipped below the government's target range, requiring fiscal policy to do more than simply accelerate implementation of existing measures, the advisor continued.

He noted last week's Politburo meeting said Beijing would "attach great importance" to economic difficulties and challenges, language rarely used previously, alongside pledges to "unveil additional policy measures" and "step up counter-cyclical efforts," signalling policymakers are increasingly concerned about the pace of the slowdown. (See MNI: PBOC Seen Cutting Rates, RRR Modestly In H2 – Advisors)

Zhao Xijun, co-dean of the China Capital Market Research Institute at Renmin University, said weak consumption was the main reason for slower Q2 growth, noting additional measures must be taken to lift consumption’s contribution to GDP growth from 2.1 percentage points in H1 to at least 3 pp, helping full-year growth reach around 4.7%. He highlighted the slow pace of fiscal spending in H1 and called for fiscal support alongside greater investment in areas such as elderly-care infrastructure.

Fiscal expenditure rose just 1.5% y/y, well below the full-year target of 4.4%, contributing to a CNY971.5 billion increase in government deposits held in the banking system.

Over the longer term, Zhao expects China's fiscal role to expand further as public services improve, implying the deficit-to-GDP ratio may eventually rise above the current 4%, although only gradually as economic growth and tax revenues permit. (See MNI INTERVIEW: China Likely To Announce New Fiscal Stimulus)

FISCAL-MONETARY COORDINATION

Dong Ximiao, chief economist at Merchants Union Consumer Finance, expects authorities to accelerate issuance of ultra-long special treasury bonds and local government special-purpose bonds in H2 to support investment. He said fiscal interest subsidies would increasingly complement the PBOC's structural monetary tools by supporting equipment upgrades, consumer goods trade-in programmes and technological innovation. Dong also suggested extending interest subsidies to auto loans and first-home mortgages to stimulate vehicle sales and the property market.

The advisor added fiscal authorities will expand support by providing guarantees and interest subsidies for corporate bond issuance of technology companies and enterprises involved in the "six networks", including electricity, computing infrastructure and railways.

Since 2025, fiscal authorities and the PBOC have jointly subsidized technology-innovation bond issuance to lower financing costs for high-tech firms.

DEBT RESOLUTION

The advisor said local government debt restructuring has significantly constrained fiscal spending, contributing to the 2.4% y/y decline in infrastructure investment in H1.

Most local government special-purpose bond issuance has been used to refinance existing debt rather than fund new projects, strengthening the case for additional bond quotas, he said.

China's Ministry of Finance launched a CNY12 trillion local government debt-resolution programme in 2024, targeting the elimination of implicit local debt by 2028.

Around CNY3 trillion remains to be resolved, according to the advisor, who warned that debt restructuring would continue to weigh on local governments' ability to support growth over the next three years. Debt pressures should begin to ease after 2029, he said.

MNI: PBOC Seen Cutting Rates, RRR Modestly In H2 – Advisors

The People's Bank of China is likely to lower its policy rate by 10 basis points in the second half of the year and reduce the reserve requirement ratio (RRR) to accommodate government bond issuance, policy advisors told MNI, while relying increasingly on structural policy tools to support key sectors.

Lian Ping, director of the China Chief Economist Forum, expects the PBOC to cut policy rates by 10bp to reinforce its easing bias over the remainder of 2026, although scope for further reductions is limited after a decade-long rate-cutting cycle. However, there is still room for further RRR cuts, Lian said, predicting the ratio could fall from the current 6.3% to below 5% over the next five years through 25-50bp reductions as the financial sector is restructured.

Maintaining ample liquidity is essential as banks remain the primary providers of credit and bond purchasers, while also supporting investment in priority sectors such as advanced technology, he added. (See MNI INTERVIEW 2: China's Econ Restructure Needs More Support)

However, interest-rate and RRR cuts are not urgently needed as liquidity remains ample, said Su Jian, professor at Peking University's School of Economics and director of the National Center for Economic Research. M2 rose 8.0% y/y and aggregate social financing outstanding increased 7.4% y/y in the first half, while producer prices turned positive, indicating the main constraint is weak financing demand rather than elevated funding costs, he noted.

The PBOC could still implement a modest RRR cut should economic growth slow further in the third quarter, he added. While Q3 GDP growth is likely to ease from the 4.7% recorded in the first half, favourable base effects should keep full-year growth above 4.5%. Su said information transmission, software and IT services, and leasing and business services remain key growth drivers, while construction and manufacturing continue to weigh on activity.

Dong Ximiao, chief economist at Merchants Union Consumer Finance, said the PBOC could cut the policy rate by 10-20bp if economic headwinds intensify, although pressure on banks' net interest margins would likely limit reductions in the loan prime rate to 5-10bp. He expects the central bank to lower the RRR by 25-50bp if government bond issuance accelerates or liquidity conditions tighten.

The calls for lower rates follow last week's Politburo meeting that pledged to "comprehensively utilise and adjust monetary policy tools in a timely manner". (See MNI PBOC WATCH: Q3 Rate Cut Eyed As GDP Slows)

STRUCTURAL TOOLS

With broad monetary easing becoming less effective, advisors expect the PBOC to rely more heavily on structural policy tools.

Lian said the central bank is likely to expand the scale of targeted relending facilities while lowering their funding costs, particularly for high technology, consumption and private enterprises. 

Earlier this year, the PBOC cut rates on structural lending facilities by 25bp, established a CNY1 trillion relending programme for private enterprises, increased quotas for agriculture and small-business relending by CNY500 billion to CNY4.35 trillion, and expanded the technology innovation and equipment upgrading facility by CNY400 billion to CNY1.2 trillion.

Su said additional policy-based financial instruments should be deployed alongside local government special-purpose bonds, arguing fiscal policy is better suited than interest-rate cuts to addressing weak domestic demand.

POLICY BENCHMARK

Markets have speculated the PBOC could formally replace the seven-day reverse repo rate with the overnight reverse repo rate as its main policy benchmark in the second half. Because the overnight rate is lower, such a move would effectively amount to a policy easing.

While adopting the overnight rate as the primary policy rate remains an objective, Su doubted whether a full transition would occur this year. The overnight reverse repo is currently used mainly for short-term liquidity management, while the seven-day reverse repo remains the policy benchmark, he said, noting a complete transition is unlikely before 2027.

Lian expects the PBOC instead to increase the size and frequency of overnight reverse repo operations in the second half, gradually signalling its intention to make the overnight rate the main policy benchmark.

MNI INTERVIEW: Services Growth Firm, But So Are Prices- ISM

The U.S. services sector in showed resilience in activity and demand last month, even as costs remained elevated amid ongoing supply chain pressures and employment was subdued, Institute for Supply Management services chair Steve Miller told MNI Wednesday.

"Thirteen of the 18 industries are reporting an increase now," he said in an interview. "I think it's very broad. It's not specific to the World Cup."

The ISM services index edged up by 0.1pt to 54.1 in July, slightly below expectations for a larger increase. The composition of the report was mixed. The new orders and business activity components increased but there was a decline in the employment component that reversed its large increase in June.

"I think we're still at mid 50s throughout the year. It looks very solid. There's nothing I'm seeing that's saying there's slowdown," Miller said. For the last six months the PMI has been between 53.6 and 56.1.

EMPLOYMENT CONTRACTION

New orders were firm at 57.2 versus 55.1 previously, but the backlog of orders dropped to neutral and employment headed back into contraction territory at 47.4 from 51.2. 

The 12-month employment index average stands at 48.7. "We're seeing sustained low or no growth from an employment perspective," Miller said. 

Miller presented a cautious tone about the chance that increased new orders will lead to faster growth in coming months. "It depends on what happens with order backlog," he said. The new orders index has been in expansion above 50 for 14 consecutive months, the ISM report said. 

"With new orders being so high, fifth highest in the last 26 months, if we see that flow through like we have in previous months to backlog, then I think we'll see a positive impact on the new hiring."

INFLATION PRESSURES

Inflation pressures remain elevated with prices paid up at 70.3, up from 67.7 in June. The index’s 12-month average reading climbed to 68.1 percent, its highest level since it was 69.9 percent in April 2023, ISM said. (See: MNI INTERVIEW: Fed Set To Hike Rates Once This Year-Haslag) 

There were 23 commodities reported up in price, 6 reported down in price, and 8 reported in short supply in July. 

"It's very clear that we're seeing the petroleum-related costs flowing through to prices paid," Miller said. 

MNI INTERVIEW: Fed Set To Hike Rates Once This Year-Haslag

The Federal Reserve will likely raise interest rates once this year in September, in order to dampen inflation that is too elevated for comfort now but should begin to subside if oil prices stay low, former Dallas Fed economist Joseph Haslag told MNI. 

“There’s going to be a hike. If the data stay on the trend they seem to be on now, I think there will be one 25 basis point hike before the end of the year,” Haslag said in an interview. “It will be in September but it will be the last one of the year.” 

Haslag says inflation has been above target for too long and trended in the wrong direction this year, making policy overly loose against the backdrop of a strong economic performance. 

“If I look at either the one-year or the two-year Treasury security, I would say the Fed's current stance is a little bit more expansionary than I wish it would be,” he said. “One hike sends both the right signal and it's about the right level for rates based on conditions that I can see right now.” (See MNI INTERVIEW: Fed To Consider Hike In Sept. - Lockhart) 

The federal funds rate target needs to be lifted closer to the two-year Treasury rate in order for policy to be considered neutral, he added. “Then I think we've got a chance to to slide into the 2% (inflation goal). It may take some time, though. It may be in the middle of ‘27 before we get there.”

Haslag, now a professor at Auburn University, believes core inflation will hover between 3% and 3.5% for the remainder of the year, still far above the Fed’s 2% target but about 50 basis points below his own estimates from May, which had embedded worries of a more prolonged disruption of the Strait of Hormuz. 

COMMUNICATIONS WOBBLE

The Fed held interest rates steady last week and longer-dated bond yields rose sharply as investors doubted the central bank’s commitment to bringing down inflation, in part because of what Haslag described as mixed messaging from the new chair. 

“He's in a difficult situation. When you want to make something your own, sometimes you forget that you're really standing on the shoulders of giants,” said Haslag. 

“He’s trying to do that balancing act because he keeps getting inflation. His words are kind of muddled and the market is already seeming to jump on every bit of volatility-inducing words that he chooses.”

Haslag said former chair Alan Greenspan, whom Warsh has held up as a model, used to do a great job of listening to his peers and crystalizing the committees views. 

“Warsh is either going to do that, or there's a risk that he's going to lose control. He's not going to be the point person. He'll be the spokesperson, but I don't think he'll be the force that's driving the FOMC,” he said. 

BALANCE SHEET 

Similarly on the balance sheet, Haslag doesn’t think the chairman and other FOMC members pushing for a smaller footprint in financial markets has clearly articulated the rationale for it. 

“Once you're in a world with abundant liquidity, I'm not sure that I understand that the size of the Fed’s balance sheet has significant consequences,” he said. 

MNI INTERVIEW: Fed Could Hike 100bps Within 6 Months-Croushore

The Federal Reserve could raise interest rates by as much as 100 basis points in the next six months as inflation proves stubbornly elevated, Dean Croushore, a Philadelphia Fed visiting scholar and former staff economist at the Philadelphia Fed Bank told MNI.

"The outcome at the July meeting was expected, and the market reaction will help the Fed raise rates a bit at the next meeting and a few more meetings to come. Maybe a full percentage point over the next 6 months," Cruoshore said in an email.  

Eventually the Fed will be able to lower rates again but that prospect is far off for now. At that point the FOMC could execute "a gradual reduction in rates as inflation comes down, which could be a while."

Croushore, now a professor at the University of Richmond, said he is a fan of Chairman Kevin Warsh's effort to revisit central bank communications -- namely by providing less of it. Bond markets reacted adversely to comments made during the July press conference, with longer-dated yields moving sharply higher.

"I like the new chair’s approach as I think shaking up the Fed system a bit will be beneficial, as well as thinking about different major structures," he said.

Cruoshore is also hopeful about the outcome of Warsh's five task forces, particularly the one focused on the balance sheet.

"I would hope they shrink the balance sheet and stop paying a set interest rate on all reserves," he said. (See MNI INTERVIEW: Fed To Consider Hike in Sept - Lockhart)