With widespread speculation that the Bank of Japan’s yield curve control (YCC) policy could be reviewed, or even phased out, as early as next week, investors have been scrambling to exit.
A sell wall catapulted Japanese 10-year government bond yields more than 4 basis points to 0.54%, the highest since mid-2015 and above a recently widened band of -0.5%+ 0.5% set by the BOJ in a shock decision just a few weeks ago.
Stress was evident across the yield curve and challenged the BOJ’s announcement on Friday of a new round of emergency purchases worth about 1.4 trillion yen ($10.84 billion yen) , while already holding 80 to 90% of some bonds.
“The attack on the BOJ, mainly by foreign investors, continues, and this is putting upward pressure on yields,” said Takafumi Yamawaki, head of Japanese rates research at JP Morgan Securities.
Overseas investors sold record amounts of JGB during the week as the BOJ widened range, sensing its six-year YCC policy was on the verge of unraveling.
Markets had expected this policy to last until April, when BOJ Governor Haruhiko Kuroda, the author of Japan’s super-stimulus policy, was due to retire.
However, the tipping point appeared to be approaching when the Yomiuri newspaper reported on Wednesday that BOJ officials would review YCC side effects at their two-day meeting next week.
Not all analysts thought Kuroda was ready to back down.
“The market expects it will hike the range again for the 10-year at its next meeting,” said Naka Matsuzawa, Japan’s chief macro strategist at Nomura.
“I think it’s too early for the BOJ to give up. They still have some ammunition to defend the 0.5% yield cap.”
Indeed, the central bank can create an infinite amount of new yen to buy bonds, but it already holds more than half of the paper issued and liquidity is almost non-existent, which creates various distortions in the market.
Further widening of the range would also allow the 10-year yield to drift further away from the BOJ’s central target of zero, which would cast doubt on its credibility.
DON’T FORGET THE RBA
There is talk in markets that the central bank may reduce its three- and five-year yield targets, but history abroad suggests that tensions will remain.
The Reserve Bank of Australia (RBA) faced the same dilemma in late 2021 when it was forced to abandon its three-year return target in a painful turnaround.
With the local economy recovering faster than expected and inflation accelerating, the RBA realized that its promise to keep three-year yields at 0.1% through 2024 was no longer credible.
So he abruptly dropped everything and three-year yields soared to 0.48%, an episode that the RBA itself has admitted has caused “reputational damage” that will not be repeated.
The similarities are striking given that this week’s data showed Tokyo inflation, a leading indicator of national trends, unexpectedly surged to double the central bank’s 2% target.
At the same time, store operator Uniqlo Fast Retailing said it would raise wages by up to 40%, focusing mainly on Japan, giving hope that wages could finally start catching up with the economy and inflation.
The challenge, therefore, will be for policymakers to find a way out of the CJC without too much damage to markets.
“The bond market is very illiquid, and any big sell-off could send long-term rates up 1.5% in a very short time,” said Amir Anvarzadeh, market strategist at Asymmetric Advisors.
“So you can’t give it up overnight, you have to do it gradually.”
($1 = 129.1400 yen)