TOKYO – Yields on Japan’s benchmark 10-year government bonds breached the central bank’s new ceiling on Friday in the market’s most direct challenge yet to decades of uber-easy monetary policy.
With speculation swirling that the Bank of Japan’s policy of yield curve control (YCC) could be revised, or even abandoned, as early as next week, investors were rushing for the exits.
A wall of selling catapulted 10-year Japanese government bond yields 4 basis points higher to 0.54 percent, the highest since mid-2015 and above a recently widened band of -0.5percent to +0.5 percent set by the BOJ in a shock decision just a few weeks ago.
The stress was evident across the yield curve and defied the BOJ’s announcement on Friday of a fresh round of emergency buying worth around 1.4 trillion yen ($10.84 billion), when it already holds 80 percent to 90 percent of some bond lines.
“The attack on BOJ, mainly from foreign investors, continues, and that is putting upward pressure on yields,” said Takafumi Yamawaki, head of Japan rates research at J.P. Morgan Securities.
Offshore investors sold record amounts of JGBs in the week the BOJ widened the band, scenting that its six-year old YCC policy was on the way out.
Markets had thought that policy would linger on until April when BOJ Governor Haruhiko Kuroda, the author of Japan’s super-stimulus policy, is due to retire.
Yet the crunch seemed to move closer when the Yomiuri newspaper reported on Wednesday that BOJ officials would review the side effects of YCC at their two-day meeting next week.
Not all analysts thought Kuroda was ready to reverse course.
“The market is expecting at the next meeting that they will increase the band for the 10-year again,” said Naka Matsuzawa, chief Japan macro strategist at Nomura.
“I think it’s too early for the BOJ to give up. It still has ammunition to defend the 0.5percent yield cap.”
The central bank can, indeed, create an infinite amount of new yen to buy bonds, but it already holds more than half the paper on issue and liquidity is almost non-existent, creating a variety of distortions in the market.
Further widening the band would also allow the 10-year yield to stray further from the BOJ’s central target of zero, putting its credibility in doubt.
Remember the RBA
There is talk in the markets that the central bank could shorten its yield target to three- and five-year bonds, but history abroad suggests the strain will remain.
Much the same conundrum was faced by the Reserve Bank of Australia (RBA) in late 2021 when it was forced to abandon its three-year yield target in a painful reversal.
With the local economy recovering faster than expected and inflation accelerating, the RBA realized its pledge to keep three-year yields at 0.1 percent out to 2024 was no longer credible.
So it abruptly dropped the whole thing and three-year yields spiked to 0.48 percent, an episode the RBA itself conceded caused “reputational damage” that would not be repeated.
The similarities are striking given data this week showed inflation in Tokyo, a leading indicator of nationwide trends, unexpectedly rose at double the central bank’s 2 percent target.
At the same time, Uniqlo store operator Fast Retailing said it would hike wages by as much as 40 percent, concentrating mainly on Japan, giving hope that salaries might finally start to catch up to inflation.
The challenge, then, will be for policymakers to find a way to exit YCC without too much damage to markets.
“The bond market is very illiquid and any major sell off, could push long-term rates up to one and a half percent in a very short time,” said Amir Anvarzadeh, a market strategist at Asymmetric Advisors.
“So you can’t just abandon this overnight, you have to do it gradually.”
($1 = 129.1400 yen)