Week 03-04 update
BoJ, 50 Cent and Tankers
The fourth week of 2025 is shaping up to be an interesting one. On Monday, we begin with Donald Trump's inauguration. However, that's not the only known-unknown event next week.
Japan Central Bank and interest rate policy
On January 23-24, the Bank of Japan is likely to raise interest rates by another 0.25%. Repetition of the Black Monday 2024 edition is not excluded, i.e., a market crash on the Nikkei and chaos provoked by the yen's carry trade.
Let's examine the macro picture to assess the impact of the BoJ's decision as a catalyst.
Inflation: Cyclical inflation seems to be returning, reminding us that we are in a regime of structural inflation. US inflation rates are rising steadily and persistently. Higher inflation means a higher cost of capital.
Interest: The bond market wants to tell us something. Bonds on the long side of the yield curve (30-year and 20-year) offer higher yields, implying they are less attractive to debt traders. The situation is similar for ten-year US Treasuries.
I really like the following quote by James Cavill on the role of the bond market:
"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a 400 baseball hitter. But now, I would like to come back to the bond market. You can intimidate everybody."
The following chart shows the performance of 10-year government bond yields. Each candle represents three months.
Price action suggests that the probability of higher yields is not diminishing. US Treasury weakness is likely to continue.
The debt ceiling: the timing of the BoJ decision could not be better, considering that the US will once again reach the debt ceiling on 23 January 2025. Of course, this is neither the first nor the last time. Moreover, this event alone does not imply a market crash. However, the debt ceiling and the BoJ decision are an explosive combination.
The indices: The broad indices have been performing well since early 2025. Divergences among some components suggest market weakness that, given a potential catalyst, could turn into a correction. An example is the ratio of the microchip index to the S&P500.
On the other hand, indicators such as discretionary vs. staples and defensive vs. cyclical support the bull market in broad indices. Although, they do not rule out the role of rising inflation and increasing US bond yields.
Next week's BoJ decision is a potential catalyst that could trigger panic selling. Of course, this is not the only scenario, much less a guaranteed one. In my opinion, the scenarios for the coming week look like this:
The BoJ raises interest rates by 0.25%, leading to a Nikkei collapse and a dollar/yen sell-off. The probability I attribute to such a scenario is at least 30%.
The BoJ raises interest rates by 0.25%, which does NOT lead to a collapse in the Nikkei and dollar/yen sell-off. This scenario has the least weight in my eyes. I assign less than 20% probability to it.
The BoJ does not raise rates by 0.25%; the market (probably) continues its bull run. This scenario has the most weight, and I assign it a 40-50% probability.
The probability distribution is as follows: 60-70% probability of no market crash and 30-40% probability of one. The likelihood of a repeat of the Black Monday 2024 version is high enough to account for them and take action but not so high as to panic and sell.
Then, how to bet on rising volatility?