The Bank of Japan on Friday loosened its yield curve control (YCC) policy, a pillar of the central bank’s efforts to limit borrowing costs and stimulate the economy.
(Bloomberg) — The Bank of Japan on Friday loosened its yield curve control (YCC) policy, a pillar of the central bank’s efforts to limit borrowing costs and stimulate the economy.
The vaguely-worded move sent a shudder across asset classes on Friday in Asia — even after rumors of such a move had roiled trading desks the prior afternoon in New York. Yields on 10-year Japanese government bonds jumped to their highest since 2014, while the yen seesawed between gains and losses as investors speculated whether this tweak was a precursor to more drastic changes for Japan’s ultra-easy monetary policy.
Such volatility highlighted the challenge facing BOJ Governor Kazuo Ueda, who took over earlier this year and is tasked with phasing out the policy without triggering market turmoil. The stakes are high, with significant implications for global fund flows. Japanese investors are the biggest foreign holders of US government debt, and own sizable amounts of European bonds.
Here’s how the BOJ’s yield curve policy works and how it’s been changed.
1. What’s a yield curve, and how does YCC work?
Bond yields, expressed in annual percentage terms, show the rate of return you expect to get on a particular fixed-income security. The gap between yields on different maturity instruments is known as a yield curve. Most of the time, investors demand higher returns for locking away their money for longer periods, with the greater uncertainty that brings. Hence, yield curves usually slope upward.
YCC was introduced in 2016 after years of heavy bond buying under quantitative easing. The BOJ wanted to keep short- to medium-term rates low while allowing long-term rates to go higher. The goal was to encourage consumers to spend and head off the risk of deflation, without depressing returns for financial institutions including life insurers.
The target for the 10-year government bond yield is set around zero percent, while short-term rates are set at -0.1%. Initially, there was no clear trading band around that, although over time it was understood that the central bank was allowing a band of around 0.1 percentage point in either direction. In 2018, the BOJ widened the band, saying the 10-year yield would be allowed to move about twice as much as the initial limit. While market players concluded the new limit was 0.2 percentage point, the BOJ clarified that the band was 0.25 percentage point in both directions in 2021. Last December, the BOJ tweaked it further to allow long-term yields to move 0.5% in both directions.
2. What did the BOJ do today?
Rather than announcing a new band, the BOJ said it will control 10-year yields “flexibly.” It will allow them to rise above the 0.5% level that is now a reference rate, while “nimbly” using bond purchases to guide yields. The central bank will also offer on a daily basis to buy 10-year JGBs at 1%, effectively raising the yield cap to that level from 0.5%. By keeping the 0.5% target in place, the BOJ appears to be trying to rein in speculation of further policy tightening ahead.
3. Why did it need to tweak the band?
The BOJ’s monetary stimulus program, spearheaded by Ueda’s predecessor Haruhiko Kuroda, has turned the bank into the largest owner of stocks and government bonds in Japan. Yet it has failed to boost the world’s third-largest economy in a sustainable way. It’s also undermined the value of the yen, pushing up import costs and consumer prices. Furthermore, there have been signs that Japan’s debt market, the world’s second-largest, was no longer functioning as it should. With more than half of all government bonds now the property of the central bank, trading in what should be an easily-available asset thinned.
The BOJ has said tweaks to the YCC band are aimed at improving the functioning of the market, a position it reiterated Friday in its presentation below.
4. Is this the end of Japan’s easy-money era?
The BOJ says it’s not. Ueda, like Kuroda in December, denied it was a precursor to tighter policy.
“This move isn’t a step toward normalization,” he told a news conference on Friday. “As we’ve repeatedly said, these moves are aimed at bolstering the sustainability of YCC.”
But many economists interpreted the tweak as laying the preliminary groundwork for exiting a decade of extraordinary stimulus policy.
5. What’s the impact on global markets?
The BOJ is the world’s last major anchor of rock-bottom interest rates, and Japanese investors have spent more than $3 trillion offshore in search of higher yields. Economists warn that even a small shift to policy normalization may prompt Japanese cash to flood out of global markets and back home. In addition to being the biggest foreign holders of US government debt, Japanese funds have massive investments in everything from Brazilian sovereign debt to European power stations and high-risk loans.
Speculation of a more significant shift, such as the abandonment of YCC, is likely to bolster the yen and deal a blow to bond markets where Japanese investors have significant holdings. This could include bonds in Australia — where benchmark yields jumped as much as 20 basis points on Friday — France and the US.
Within Japan, expectations of eventual tightening boosted shares in banks, which have seen their interest income crushed by years of low rates. The nation’s biggest lender Mitsubishi UFJ Financial Group Inc. rose as much as 5.6%, while Mizuho Financial Group Inc. and Sumitomo Mitsui Financial Group Inc. also rose. Banks and insurers were among the few industry groups to rise on the Topix, which fell 1.4%.
6. What are the possible downsides of the tweak?
The BOJ wants to avoid premature speculation of rate hikes. It’s still uncertain how successful Ueda will be in relaxing its control over yields without causing huge market volatility. Friday’s tweak, which was reported in advance by the Nikkei, could also raise questions about his credibility.
The BOJ’s wording also risks undermining the clarity of its policy communications. The yen’s volatility following the announcement may be a reflection of this.
–With assistance from Paul Jackson.
(Updates with the BOJ Governor’s comments and move in banking shares)
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