Summary
- The Bank of Japan announced on December 19 that it would widen the upper-bound target for the 10-year JGB yield, to 0.5% from 0.25%.
- This somewhat sudden move raises some key questions.
- We believe the surprise bump in Japanese yields may somewhat dent the BOJ’s own balance sheet but not trigger larger-scale market disorder.
By Tokufumi Kato
We believe the surprise bump in Japanese yields may somewhat dent the BOJ’s own balance sheet but not trigger larger-scale market disorder.
Buffeted by rising inflation, a weak currency and accelerating wage growth, the Bank of Japan announced on December 19 that it would widen the upper-bound target for the 10-year JGB yield, to 0.5% from 0.25%, while increasing monthly JGB purchases, to 9 million yen from 7.3 trillion, to help ensure orderly market operations. This somewhat sudden move raises some key questions:
Will the BOJ pivot from its “yield curve control” ((YCC)) policy in 2023?
Perhaps—what with Governor Haruhiko Kuroda set to leave the bank and the upcoming Shunto wage negotiations between unions and employers to be finalized in the spring. Meanwhile, the OIS market implies that the BOJ will be even less accommodative next year, with pricing near 0.75% on the 10-year Japanese government bond.
What are the consequences for markets?
For Japanese investors, hedged foreign bond markets now appear less attractive, which could trigger flows back home. As for the yen, we believe it could strengthen as Japanese investors sell foreign assets to repatriate capital, while Japanese exporters hedge to offset lower demand for their relatively more-expensive goods. On the margin, this could lead to some broad dollar weakness, as now both the ECB and the BOJ have taken a more hawkish stance.
In other asset classes:
- Fixed Income: In our view, global yields would likely increase as Japanese investors potentially continue to sell foreign bonds and buy JGBs. And global term premiums could rise if the BOJ looks to abandon negative rates in a larger policy pivot, as the market is currently pricing.
- Equity: Higher rates and tighter financial conditions could dampen Japanese equity markets more severely than in the U.S. or Europe. Active investment strategies may outperform as factor and sector selectivity become more critical. Potential winners could include Japanese banks and domestic companies less sensitive to global growth and relative-currency moves.
Could a ‘disorderly pivot’ cause broader disruption?
So far, we believe markets are trading in an orderly manner: The yen strengthened; JGB yields rose; and Japanese equities declined as expected. However, the picture isn’t entirely clear, as many participants are on holiday or laying low through year-end.
Ultimately, in our view, losses on higher yields will be mostly concentrated on the BOJ’s own balance sheet, as it is the largest holder of Japanese bonds (about 50%). As a result, we don’t anticipate any large-scale disorderly events such as the EU’s Pension/LDI tumult last October.
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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
For further details see:
What The BOJ's Policy Shift Means