Yen Replaces Bonds in Driving Speculation of a BOJ Policy Change

The yen has eclipsed bond market liquidity as a potential catalyst for a further adjustment to the Bank of Japan’s monetary policy.

(Bloomberg) — The yen has eclipsed bond market liquidity as a potential catalyst for a further adjustment to the Bank of Japan’s monetary policy.

Despite the BOJ explicitly citing debt-market issues as the reason for changes to yield-curve control, bond liquidity has been broadly stable since the most recent policy tweak on July 28. Conversely, the yen has weakened more than any other major currency in the past six months and traded at levels that saw Japan step into the market last year.

Governor Kazuo Ueda’s meeting with Japan’s prime minister this week fanned speculation that another policy change is in store as the government considers fiscal support to help households and businesses deal with inflation. The recent absence of additional effort from the central bank to slow a rise in yields to a nine-year high further bolsters the case.

“The yen is a determinant of the BOJ’s tolerance of a rise in yields,” said Kaoru Shoji, a rate strategist at SMBC Nikko Securities Inc. in Tokyo. “There’s a good chance that the BOJ will have to change policy again in the relatively near future should yen depreciation deepen materially.”

The BOJ doubled a ceiling for the benchmark 10-year yield in December to avoid hurting the functioning of the bond market and to make its yield-curve control more sustainable.

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While the July statement listed market functioning as a reason for a more flexible execution of the program, Ueda said foreign-exchange volatility had also been a factor.

Market functioning, as measured by bid-ask spreads, has shown improvement since March except for a brief disruption around late July when the BOJ doubled the yield limit to 1%. A Bloomberg gauge also showed yield-curve dislocations that were visible in the first quarter have almost vanished — another sign of improved market functioning and liquidity.

The BOJ in February quadrupled the cost for its securities-lending facility, making it harder for short sellers to borrow bonds from the central bank. The BOJ’s decisions in December and July to loosen its grip over the bond market has also seen a pickup in trading among private investors.

Whether the BOJ will have to alter yield-curve control further depends on US yields, said Takuji Aida, chief Japan economist at Credit Agricole CIB in Tokyo.

“My base-case scenario is that US yields will either stay around current levels or fall once the Fed will start to cut rates next year,” he said. “That will give the BOJ some breathing room and let it continue with the current easing framework.”

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