The Bank of Japan finally appears to be preparing for an end to its controversial yield curve control program, a policy that has helped provide an anchor for interest rates around the world.
(Bloomberg) — The Bank of Japan finally appears to be preparing for an end to its controversial yield curve control program, a policy that has helped provide an anchor for interest rates around the world.
BOJ Governor Kazuo Ueda surprised investors on Friday by announcing the central bank would allow yields to rise above a ceiling it now calls a point of reference. That paves the way for a future normalization of policy that has implications for a wide range of global assets and for markets heavily exposed to Japanese money, even if investors need not panic for now.
While the move caused the yen to strengthen against the dollar and Japanese government debt yields to rise, the BOJ has laid all the groundwork for a relatively orderly end that contrasts with the reputational damage and market gyrations that accompanied the chaotic collapse of the Reserve Bank of Australia’s YCC in 2021.
But Ueda’s surprise move may raise questions about his communication strategy at an early stage of his five-year term. Economists also warn that bond bears and yen bulls should remain on guard. Ueda is in no rush to stop buying JGBs and will continue to massage yield moves going forward to stop them spiraling upward.
Japan’s heavily indebted government will also be hoping that the cost of issuing debt doesn’t spiral upward as it looks for ways to pay for its ramped-up defense and childcare spending plans.
“This is the ‘de-facto’ abolishment of yield curve control,” UBS economist Masamichi Adachi said. While he played down the linkage toward future tightening moves, he said a lack of policy guidance did leave open the possibility of the BOJ raising its short-term interest rate.
At Friday’s board meeting, the BOJ left that rate untouched at -0.1% and its long-term bond yield target at zero. The bank also acknowledged that inflation was much stronger this fiscal year than it expected as recently as April, while insisting it would slow below 2% the following year, in a justification for continuing with stimulus.
The key move that jolted markets was the BOJ’s switch to a more flexible approach on bond buying. The bank turned its heavily defended yield cap into little more than a yardstick. The BOJ will now allow movements beyond 0.5%, further diluting the meaning of a 0% target aimed at stimulating the economy and prices.
The central bank switched its daily offer to scoop up bonds at 0.5% to a new fixed rate of 1%, essentially drawing its line in the sand on bond yields there. Of the 18% of polled economists who disagreed with the consensus and said the BOJ would adjust YCC in July, many of them had expected a widening of the movement to 1%. Some watchers of the central bank had said a band so wide would render the notion of a zero target largely meaningless.
Since the YCC was introduced in September 2016 as a new way of keeping bond yields low, the framework has slowly been adjusted toward greater flexibility over the years.
Speaking after the decision, Ueda himself said he didn’t expect yields to get to 1% under current circumstances in a remark that lays out the effective redundancy of the tool.
“I don’t think it’s appropriate for yields to go up to 1%,” Ueda said. “Given that until yesterday yields were below 0.5%, and we’ve decided we’ll flexibly conduct operations if yields go beyond 0.5%, I don’t expect yields to move to 1%.”
Still, any move further in the direction of conventional central bank thinking will likely be welcomed by traders desperate to rid themselves of the bond-buying whale in their market. Their hopes are echoed by commercial banks after years of complaints over the BOJ’s negative interest rates hitting profits from conventional lending.
Currency players will need to recalibrate decisions on where best to park their money while Japanese investors may mull whether to pull some of their money out of heavily exposed markets including Australia, France and the Netherlands.
A smaller policy tweak by the BOJ in December roiled a wide range of asset markets including US stock-index futures, the Australian dollar and gold, in an indication of the potential ripples that may be caused by a shift in approach by one of the world’s most important central banks and last pillar of rock-bottom yields.
“Higher Japanese rates could have a ripple effect across other major fixed income markets with sizable shares of Japanese bond holdings,” such as in French and Australian debt, said Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management in Singapore. He also said the move would likely drive the yen stronger for the rest of the year.
Other analysts flagged the possible impact for investors in the US.
The BOJ’s decision “acts as a headwind at the margin for long-duration US bonds and equities,” said Paras Anand, chief investment officer of Artemis Investment Management. “It similarly continues to weaken the attraction of yen funded carry trades, and arguably carry trades in general as the upward pressure on rates becomes more widespread.”
Market players will likely be far more cautious over further surprises going ahead, given the lack of warning for the BOJ move.
Ueda’s predecessor Haruhiko Kuroda was widely criticized in December for his shock move to double the yield range. The current incumbent may also take some heat for the latest decision.
Investors will now have less clarity on when the central bank will step in.
“Market players will be watching when the BOJ will intervene as the BOJ is half in the market, and half out,” said Ayako Fujita, chief economist at JPMorgan Securities Japan, who had forecast YCC adjustment at this meeting. “This creates another likely problem for the BOJ.”
What Bloomberg Economics Says…
“The move tarnishes Governor Kazuo Ueda’s reputation as a clear communicator. Ueda has been consistent in sending dovish signals. But his actions may now be perceived as unpredictable and even hawkish.”
— Taro Kimura, economist
For the full report, click here
In more normal times, future policy guidance should help investors gauge when a central bank will change rates, Ueda has argued. Ueda as a board member was the godfather of BOJ guidance more than two decades ago. That suggests the BOJ’s future course will eventually be built around a short-term interest rate with clear guidance, with Friday’s move a step in that direction.
“I also thought they wouldn’t adjust policy based on what Governor Ueda has said,” said Takeshi Minami, chief economist at Norinchukin Research Institute. But Ueda had warned that any change to YCC would have to come as a surprise, so damage to his credibility should be limited, Minami added.
The governor took time to explain in his press briefing that with inflation well above target, real interest rates had been getting lower and lower, a development that helps justify allowing yields to move higher. He repeatedly said that pre-emptive moves needed to be taken given upside risks to inflation, comments that underscored the view that the BOJ is sensing it is closer to its stable price target.
Still, higher yields will have implications for the government. Prime Minister Fumio Kishida, who named Ueda to replace Kuroda, has yet to finalize funding for major increases in defense and childcare spending and is considering at least some bond issuance to meet the shortfall.
Japan is already the world’s most heavily indebted developed economy with public debt worth around 258% the size of gross domestic product, according the International Monetary Fund.
If 10-year yields rise by 1 percentage point, Japan’s debt-servicing payments are expected to increase by 3.6 trillion yen by fiscal year 2026, according to Finance Ministry calculations. Japan is expected to spend 22.1% of its 114 trillion yen national budget for this year on debt-servicing costs.
That suggests the government will be keen for the BOJ to keep yields from shooting up even if it no longer does so in the name of YCC. With Japan’s pandemic recovery also yet to reach a truly solid footing, the BOJ may be reluctant to let debt costs rise too quickly.
The BOJ already has previous experience of using targets and terms that have already outlived their meaning. For years after it adopted YCC it kept a quantitative easing target of buying a net 80 trillion yen of bonds per year even though it no longer needed to.
“With hindsight, this is going to be seen as a first step toward the BOJ unwinding its monetary stimulus,” said JPMorgan’s Fujita. “YCC is now becoming a mere formality.”
–With assistance from Yumi Teso, Yuko Takeo and Michael Patterson.
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