The Bank of Japan (BOJ) widens the trading range for 10-year yields.
The BOJ announced its latest change to yield curve control (YCC) on December nineteenth. Raising the 10-year yield cap from 25 basis points (bps) to 50 bps. Some interpreted the shift as the primary in an impending series of restrictive measures from the BOJ, and the yen rebounded from 137.41 to 130.58 before giving back gains.
Previously, as Japanese government bond (JGB) yields rose toward the BOJ cap, the yen weakened. But the recent political shock briefly restored traditional macro dynamics: the upper the yields, the stronger the currency in anticipation of capital inflows.
Still, there’s reason to be cautious in regards to the yen’s nascent rally.
While the market expects the BOJ to further ease the YCC, barring any political surprises, the bank’s next move in that direction could possibly be months away. Given the yen’s renewed strength, the recovery in global long-term rates of interest could put renewed upward pressure on Japanese government bond yields. This is consistent with the co-movement framework between global long-term sovereign bonds that “close substitutes“, as Federal Reserve Governor Lael Brainard explained.
Simultaneous movement of world long-term rates of interest
If global yields rise, the BOJ may don’t have any selection but to defend its latest 50 basis point yield cap by creating latest money reserves to purchase 10-year JGBs and restore curve control. That would come at a value: the yen would weaken if near-term USD/JPY momentum weakens, even when the BOJ makes further price moves later within the yr.
This isn’t the primary time the BOJ has revised its 10-year trading range. After the central bank introduced quantitative and qualitative easing (QQE) with YCC in September 2016It set a precedent with two policy changes. On July 31, 2018, the Policy Board prolonged the 10-year trading range from +/-10 basis points to +/-20 basis pointsafter which to +/- 25 basis points on March 19, 2021. The BOJ’s intervention weakened the yen because the 10-year JGB yield tested the policy cap in 2022. Until the YCC ends, there’s nothing that may prevent this from happening again.
Japanese 10-Year Yield vs. Yield Curve Control “Cap”
Possible triggers for renewed defense of the BOJ yield curve
As the worldwide economy continues to evolve beyond pandemic-related disruptions, revived growth abroad and better demand for energy commodities, amongst others, could offset demand destruction dynamics. In the UK, fiscal stimulus has replaced fiscal austerity as the federal government plans to do extend former Prime Minister Liz Truss’ energy subsidy plan until spring 2024. Japan’s economy is sensitive to global commodity prices, and an increase in prices could raise domestic inflation expectations and put upward pressure on the 10-year Japanese government bond yield.
Thus, the expected timing of the BOJ’s hawkish stance could possibly be decoupled from market developments. If the BOJ’s next policy change is predicted within the second quarter of 2023, what happens when rising yields test the BOJ’s yield curve defenses firstly of the primary quarter? The BOJ could translate the JGB downturn right into a weaker yen and print money to fund yield defense on the 50 basis point line within the sand.
Conversely, weaker-than-expected global growth, a return to austerity in major economies, easing geopolitical tensions and falling commodity prices could lower the 10-year Japanese government bond yield and reduce the likelihood of violent BOJ interventions. In fact, the yen stays sensitive to the spread between the 10-year Japanese government bond and the BOJ policy cap.
In other words, moving the goalposts further down the sphere does not imply the ball won’t get there. As long as there are goalposts, they need to be defended, and the BOJ has not yet signaled that it is prepared to offer up control of the yield curve entirely.
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Photo credit: ©Getty Images/ Hiro_photo_H
