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ETFs to Play BoJ's Surprise Policy Shift

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Bank of Japan (BoJ) unexpectedly tweaked its bond yield control policy - a move that will allow long-term interest rates to rise more. While it kept broad policy settings same - keeping short-term JGB yields at -0.1% and the 10-year yield around zero - the BOJ decided to let long-term yields to move 50 basis points either side of its 0% target, wider than the 25-basis point band set earlier.

Notably, the bank of Japan had introduced yield curve control policy in 2016. It had issued a zero interest-rate target for 10-year government bonds to counter deflationary threats and accordingly buy bonds. The implementation of a long-term target was never tried before that by BoJ. Markets had termed Japanese measures as QQEYCC then.

At the post-announcement media briefing, BOJ Governor Haruhiko Kuroda mentioned that the change was "not an interest rate hike," but to enhance bond market function. He maintained that it's too early to discuss an exit from stimulus.

Why a Stronger Yen is Needed

The country's portion of global exports declined from 7% in 1998 to 3.4% in 2021, according to United Nations data. “The yen-dollar exchange rate is important to Japan because Japan relies on imports for energy and food,” said Takuya Hoshino, an economics researcher at Dai-ichi Life, quoted on

The falling yen resulted in a financial burden on households and businesses. It weighed on Japanese wages relative to the dollar, meaning that more Japanese go abroad to work and fewer foreign workers come to Japan. The high-value-added products that are still made in Japan, such as autos, "don't see their dollar-based sales prices decline even when the yen is weak, so export volume doesn't increase," said Naohiko Baba, chief Japan economist at Goldman Sachs, quoted on

Meanwhile, Japan has been importing more tech products. Increased imports of products like smartphones and semiconductors, and exports that do not take advantage of currency depreciation, leave Japan to face deepening trade deficits, reported

Likely ETF Winners

Invesco CurrencyShares Japanese Yen (FXY - Free Report) should gain strength. Following the BoJ’s policy tweak, the yen surged to a four-month high.  "While there is still a wide gap, the hint that the BOJ is moving incrementally away from ultraloose policy should be yen positive in the near term," Kerry Craig, JP Morgan Asset Management's global markets strategist, told Reuters, quoted on Yahoo Finance.

Among the other winners, Japan ETFs are likely to gain ahead. These are WisdomTree Japan SmallCap Dividend ETF (DFJ - Free Report) and iShares MSCI Japan Small-Cap ETF (SCJ - Free Report) are to name a few here. This is because of the fact that small-cap stocks are domestically-focused and have lesser exposure to foreign economies.

Small companies, hence, protect, them from the loss of competitiveness and currency translation impact of a stronger yen.  When the yen is strong, large exporters lose a competitive advantage, as foreign buyers view Japanese goods as pricier than non-Japanese goods. As a result, small-cap stocks perform better in a rising domestic currency environment than large-cap stocks.

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