FLJH - Bank Of Japan Tweaks Its Yield Control
2023-08-01 05:05:00 ET
Summary
- The BoJ announced a change in its yield curve control (YCC) policy, which has been in effect for seven years.
- The bank’s policy has kept the 10y JGB rate at zero and its base rate at -0.1% at a time when other central banks have been raising interest rates substantially, with the US 10-year rate currently close to 4.0%.
- The Japanese economy has benefited from the easy monetary policy. The bank has slightly upgraded its view of the economy to “has recovered moderately” from earlier more qualified language.
By William H. Witherell, Ph.D.
The Bank of Japan (BoJ) decided Friday, July 28 th , to increase the flexibility of its ultra-loose monetary policy. The stated intent is to enhance the sustainability of the current easy monetary policy in a forward-looking manner and avoid a premature policy tightening. Specifically, the BoJ announced a change in its yield curve control ((YCC)) policy, which has been in effect for seven years. Under that policy the 10-year Japanese government bond (JGB) yield has been targeted at around 0 percent with a tolerable band of around plus or minus 0.5%. The bank maintained this policy by buying bonds as needed every business day to depress yields. The policy tweak is to allow more fluctuation in yields beyond this band, setting a yield cap at +1.0%. The bank will now offer to buy 10y JGBs at 1.0%. The BOJ believes this change will give it greater flexibility to deal with any materialization of the upside risks to inflation and avoid market disruptions. The immediate bond market reaction was a 10-basis-point jump in the 10y JGB rate to 0.55%. How quickly the yield will be permitted to adjust to 1.0% is unclear and will likely depend on the inflation outlook, which the bank characterizes as having “extremely high uncertainties.” The adjustments in market rate expectations around the world to this low-rate anchor for global bond markets will be another factor.
With this modest adjustment, Japan’s monetary policy remains in sharp contrast to the continuing tightening cycles pursued by other major central banks as they seek to counter rising inflation in their economies. The bank’s policy has kept the 10y JGB rate at zero and its base rate at -0.1% at a time when other central banks have been raising interest rates substantially, with the US 10-year rate currently close to 4.0%. Once the JGB rate eventually reaches 1.0%, which could happen rapidly or more likely take months, the gap with bond rates elsewhere will remain large. The change in YCC will probably put a limit on further yen depreciation, which has taken the yen to its lowest level against the US dollar in 20 years. The yield advantage of the dollar and European currencies will still be substantial.
The quarterly Outlook Report released by the BoJ contains some important changes. The inflation outlook for core CPI for fiscal year 2023 is raised sharply from +1.8% to +2.5%, while the outlook for fiscal year 2024 is lowered slightly from +2.0% to +1.9%. The bank has the objective of achieving a 2% rate of inflation that is sustainable. In June, headline inflation in Japan rose to 3.3%, which was greater than the rate in the US for the first time in eight years. It is not surprising that that bank’s concerns about inflation have increased and led to the increase in policy flexibility. It does appear that the bank still expects inflation to ease in the coming months, as do we, but the upside risks have gained weight.
The Japanese economy has benefited from the easy monetary policy. The bank has slightly upgraded its view of the economy to “has recovered moderately” from earlier more qualified language. Similarly, their view of consumption has strengthened to “has increased steadily at a moderate pace.” In the latest IMF World Economic Outlook Growth Projections, released in the last week of July, the Japanese economy is the only major advanced economy that is projected to grow faster this year than in 2022, 1.4% after 1% last year. In contrast, the Eurozone economies as a group are projected to slow dramatically to just 0.9% this year, following a strong 3.5% advance last year.
While we do not think the YCC modification is likely to change the outlook for Japan’s economy, we do share the bank’s concerns about “significant downside risks to Japan’s economic activity and prices, including the impact of a tightening of global financial conditions on overseas economies.” The continued weakness in export orders is a clear warning sign. The bank’s desire to avoid a premature tightening of monetary policy looks prudent.
Japanese equities reacted negatively to the results of the BoJ meeting, with the Nikkei 225 sliding as much as 2.4% on Friday before ending down just 0.4% and the TOPIX down even less, 0.2%. Japan stocks have been outperforming other advanced markets this year. The Nikkei 225 is up over 25% year-to-date, compared with 19.5% for the S&P 500 and 13.7% for the iShares MSCI EAFE ETF, which covers the advanced-economy markets outside of North Africa. At Cumberland Advisors we are maintaining our Japan positions in our International and Global Equity ETF Portfolios. Bearing in mind the high uncertainties and significant downside risks, we will carefully follow future developments.
Neither Cumberland Advisors nor the author hold any of the securities mentioned in their investments.
Sources: imf.org, Oxford Economics, Bloomberg.com, Goldman Sachs Global Investment Research, Financial Times, CNBC.com
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Bank Of Japan Tweaks Its Yield Control