When the Bank of Japan meets later this week, investors will be watching closely for signs that the Japanese authorities may be preparing to tweak a policy of active capping of Japanese government bond yields, which is increasingly fading, or maybe even giving up step with what its rivals are doing.
The policy, known as yield curve control, has been in place since 2016. But in a world where the Federal Reserve has been raising interest rates as quickly as possible since the 1980s, the Japanese authorities have chosen to stand their ground for a number of reasons.
In a way, it may not matter what BoJ Governor Haruhiko Kuroda says or does after the meeting later this week because, according to George Saravelos, Deutsche Bank’s global co-head of FX research, the central bank’s approach already is irreparably broken. ”
In recent months, speculators and investors have become increasingly disillusioned with the BoJ and have tried to test their limits by shorting Japanese bonds. Futures markets are showing significantly higher government bond yields than the spot market, market strategists said.
As a result, Japanese government bond yields have started to test and even exceed BoJ-imposed ceilings, Saravelos pointed out.
Now, few issues of 10-year JGB TMBMKJP-10Y, 0.256%, eligible for central bank buyback, are still trading below the YCC yield cap, he said. The rest of Japan’s tightly controlled government bond market appears to have freed itself from these restrictions, at least to some extent.
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Even as the dollar USDJPY has soared -0.73% against the yen this year, Kuroda has refused to budge on yield curve control, repeatedly insisting that the Bank of Japan will wait until inflation is reliably over her 2% target rises before she even considers a policy change.
Since the beginning of the year, the yen has fallen almost 30% against the dollar.
Economic data released last week showed that core inflation in Japan accelerated last month at the fastest pace in eight years, according to FactSet data.
With core prices rising 3% year on year, it appears inflation in the world’s third largest economy has finally surpassed the BoJ’s 2% target after decades of struggling to lift the Japanese economy out of a disinflationary malaise .
The Japanese Treasury has sought to prop up its struggling currency by directly intervening in the currency markets. Authorities have also warned they will no longer announce interventions to maximize the effect of other tactics such as jawboning and “rate checks,” in which the Treasury Department asks currency traders for prices on the dollar-yen exchange rate in an attempt to increase the interest rate move without having to use capital, said market strategists.
According to Jon Turek, the founder and CEO of JST Advisors, after Friday’s BoJ meeting ends, investors will carefully examine the latest macro forecasts to be released by central bank economists for signs that they are factoring in higher inflation expectations their numbers.
These macroeconomic forecasts are the BoJ’s closest guess to the Fed’s “dot plot,” a summary of senior Fed officials’ expectations of where the Fed’s policy rate will be over the coming months and years.
Certainly, whenever the BoJ decides to throw in the towel, it must do so carefully so as not to provoke instability in global bond markets, said Steve Englander, Standard Chartered’s global head of G-10 currency strategy.
Should JGB yields quickly rebound to a more market-oriented rate, it could trigger a “Bank of England-type shock,” Englander said.
One thing is almost certain: any sign of BoJ capitulation would likely spur the yen to appreciate significantly against the dollar, and perhaps other Asian currencies could gain sympathy, Englander said.
Another point Saravelos made in his note is that if Japan continues to try to support the yen by dumping its sizeable foreign exchange reserves, including Treasuries, it could backfire by pushing the dollar even higher drives as the US currency would appreciate in line with higher yields.
Both Turek and Saravelos warned that Japan’s attempts to support the yen by selling foreign assets could backfire by raising government bond yields.
It’s one of the reasons why relying on direct intervention in FX markets to support the yen would likely be a “futile” endeavor, Saravelos said.
However, that doesn’t mean the BoJ sees it that way. So far, the Japanese authorities have stood firm in the face of the yen’s massive depreciation. If their recent intervention attempts tell investors anything it’s that the BoJ has no “line in the sand,” Turek said.
Instead, it appears that Japanese officials simply want to ensure that any further weakening of the yen occurs in a relatively orderly manner.
U.S. stocks held on to solid gains on Tuesday, with the Dow Jones Industrial Average DJIA +1.07% up nearly 300 points, or 1%, while the S&P 500 SPX was up +1.63%, up 1.4% and the Nasdaq Composite COMP up +2.25% jumped 2%.
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