US Federal Reserve and Bank of Japan, the two key central banks, will kick off their two-day policy meetings later in the day. While US Fed is widely expected to stay put on the interest rates, BoJ has all potential to surprise the market when it announces its policy stance on Wednesday.
Japan's struggle has persisted even as the BOJ adopted unconventional measures of negative interest rates and massive asset purchases to spur consumption and investments, while also helping exports with a weaker yen. BoJ governor Haruhiko Kuroda has promised a comprehensive assessment of its current quantitative easing and negative interest rate policies. Analysts believe An optimal scenario for Japanese equities would be if the BOJ puts off any deeper cut into negative rates, while maintaining its easy stance on monetary policy.
If the BOJ, led by Governor Haruhiko Kuroda, decides to shake up its policy stance, one avenue would be to be less aggressive in purchasing longer-dated assets, thereby allowing yields to go up, while cutting short-term rates deeper into negative territory.
This would likely result in a rise in yields of US Treasuries and other government bonds, and on the margin push uplong-term borrowing costs for consumers and corporations.
Japanese investors have poured money into foreign bonds in a scramble for income-generating assets as domestic bond yield shave turned negative. This is contributing to holding global yields near historically low levels.
"The BOJ is important in part because the Japanese have been buying anything abroad that gives them yields," said David Keeble, global head of interest rates strategy at Credit Agricole Corporate & Investment Bank in New York.
Last week, the yield on 10-year Japanese government debt rose close to zero per cent, a level not seen since March, in aglobal bond market sell-off triggered by the European Central Bank's decision to refrain from expanding its asset purchase program on September 8.
The ECB's move intensified worries that major central banks are running out of tools to aid their economies.
"Japan has struck a chord in terms of the generalised perception that there isn't that much left in that tank for policymakers from a monetary standpoint," said Charlie Diebel, head of rates at London-based asset manager Aviva Investors.
"Therefore, if you still need to provide stimulus, perhaps monetary policy isn't the way it is going to be forthcoming,"
The US economy is far from robust, posting a sub-par 1.2 per cent increase in second quarter gross domestic product. However, Japan, the world's third-biggest economy, is struggling even more, eking out just 0.7 per cent growth in the same period.
The BOJ will undertake a comprehensive review of its monetary policy at its Sept. 20-21 meeting, and there is speculation it may lower short-term interest rates deeper into negative territory and change its bond purchasing program.
Fed Chair Yellen and other US policy-makers, who will convene during the same period as their Japanese counterparts, are widely expected to leave their benchmark policy rate unchanged in a range of 0.25-0.50 per cent. They will likely keep the door open for a rate increase by year-end.
To be sure, if the Fed stuns investors by raising rates within hours of their Japanese counterparts' decision, that would overshadow anything coming from Tokyo.
The consensus is the Fed will keep its powder dry given the recent patch of soft economic data. Also, it may be reluctant to raise rates, and possibly upset financial markets, ahead of a tightening presidential election on November 8.
(With inputs from Reuters)