The BoJ Bends, Breaking Pundits’ Minds

Steadfast. Iron-willed. When last we left the Bank of Japan (BoJ), policymakers were absolutely positively not going to stop capping 10-year Japanese government bond (JGB) yields at 0.25% under its “yield curve control” policy. They would continue making “unlimited” bond purchases if necessary, even if it meant the yen weakening to generational lows versus the US dollar, and use forex reserves to put a floor under the yen if deemed necessary. But that changed Tuesday, when the BoJ suddenly reversed course and loosened its pegged rates. 10-year JGB yields jumped, the yen strengthened and pundits far and wide called it a gamechanger with global implications—the rate rise being just the tip of the iceberg. But we think a more sober, less-theatrical analysis reveals this wasn’t so huge a shift.

For one, pegs are made to be broken, so it shouldn’t be too surprising that Haruhiko Kuroda and company took advantage of a global fall in long rates to make some tweaks and avoid the perception that it was capitulating to market forces. At Tuesday’s meeting, policymakers raised the 10-year JGB yield’s allowed bandwidth to 0% plus or minus half a percentage point, effectively setting the ceiling at 0.50%. But lest you think this is some big pivot, they also upped their monthly JGB purchases from $55 billion to $67 billion per month.

When announcing the move, the BoJ cited concerns about market function—not a shift in its inflation outlook. Reading between the lines, we would guess policymakers are arguing they successfully beat the JGB market into submission when defending their peg earlier this year and that continuing to do so would now bring more risks than benefits, including speculative attacks and difficulty pricing corporate bonds and other assets that use JGBs as a reference rate. Increasing its JGB purchases—and leaving the policy rate at -0.10%—seemingly underscores its belief that even with the recent uptick, inflation remains too slow, with feeble monetary drivers masked by energy prices lately. Hence it remains committed to what it views as “loose” policy—negative rates and quantitative easing (QE) bond buying—which we have long said amounts to the monetary beatings will continue until morale improves. Banks will likely still struggle to lend amid slim net interest margins. JGBs should remain in short supply as the BoJ keeps adding to its huge holdings. And international investors will probably still see little to no reason to plop some money in the yen—not when all other comparable assets globally have much higher yields.

As a result, all the articles seeing the move as a threat to global stocks’ latest rally seem a tad overblown. For one, the yield move that spurred so many headlines is … not big. The BoJ’s announcement sent 10-year JGB yields up to 0.41% on Tuesday, and Western yields rose in sympathy.^[i] Pundits argue Japanese investors now have ample incentive to repatriate yen, which will send Western yields even higher—hitting stocks in the process. But hold the phone. Wednesday, Japanese yields rose again—to 0.47%. Yet most Western yields didn’t follow suit.^[ii] Furthermore, this theory misses the fact “yield curve control” mostly created oddities, like 9-year JGBs yielding more than 10, and 15-year yielding still more than that. If those didn’t drive repatriation, please explain why a 16 – 20 basis point move up would be such a huge development.

All else equal, money flows to the highest yielding asset. That remains the dollar, with 10-year US Treasurys yielding over three full percentage points more than 10-year JGBs. The BoJ is still adding to its JGB portfolio at breakneck speed. The Fed, BoE and now even the ECB are shrinking theirs. The BoJ now owns over half the outstanding supply of JGBs, creating liquidity issues. Government bonds in the US, UK and eurozone are much more abundant.

Perhaps most importantly, despite the BoJ’s protestations, Tuesday’s move didn’t come as much surprise to anyone. Markets have seemingly expected the BoJ to do something like this for months. This is likely why 9-year maturities paid more than 10-year. It is also likely why market-set, non-pegged 15- and 30-year yields barely budged. They pre-priced the move. Investors know better than to take central banks at their word, and it was only a matter of time before the BoJ found a plausible path to loosen its peg. Investors have long known keeping it at 0.25% was unrealistic. They may not have known the timing, but investors have positioned accordingly. Note: JGB yields’ jump didn’t trigger a wave of forced selling, and the fact yields settled well below the new ceiling shows there wasn’t much pressure. If anything, markets probably expect too much from the BoJ over the next year, with market-based indicators implying 0.4 percentage point worth of rate hikes and a half-point rise in the 10-year JGB yield from here. That doesn’t seem terribly realistic given energy prices and the weak yen are basically Japan’s only inflation drivers at this point … and energy costs are now falling. If the BoJ didn’t react to those forces earlier this year, when they were more acute, it is hard to imagine it doing so as energy price spikes retreat further into the rear view—even with a change of leadership looming next April.

So no, we don’t see this as some monumental shift for Japan or the world. It is easy to get fooled by the direction of a move like this, especially when 10-year JGBs yields’ rise looks huge on a chart. But that is because the chart zooms in on a very low level. Next to US, UK, German and French yields, the 10-year JGB looks very small indeed—too small to drive some big shift in international capital flows.

Exhibit 1: Japanese Yields Are Still Low

Source: FactSet, as of 12/21/2022. 10-year US Treasury, UK Gilt, German Bund, French Treasury and JGB yields, 12/31/2021 – 12/20/2022.