JAPAN’S government bond yields are edging toward the upper limit of the central bank’s tolerance level, raising questions over how policy makers will respond to the challenge.
As the 10-year yield approaches the 0.25% mark, the Bank of Japan (BoJ) could boost scheduled purchases, buy debt outside of its normal operations, as well as offer to secure an unlimited amount of bonds at a fixed rate in a repeat of what happened in July 2018.
The BoJ’s response will determine whether Japan can defy the worldwide rise in yields as traders ramp up bets for policy normalization. Governor Haruhiko Kuroda has dismissed talk of a rate hike and domestic inflation remains anemic but the global repricing is still altering expectations for Japan’s bond market.
“It’s hard to expect JGB yields to defy BoJ’s aggressive buying and continue their climb as the rise is driven by external factors,” said Naomi Muguruma, a senior market economist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “The BoJ has the option to conduct fixed-rate operations broadly, not just the 10-year zone, to counter a surge in yields.”
Japan’s 10-year yield has risen for two straight months and hit 0.21%, its highest since January 2016 on Tuesday. Under its curve control policy, the BoJ has a desired trading range for the benchmark of 0.25% either side of zero.
Here’s a closer look at the various bond-purchase operations the BoJ can deploy to curb the advance:
The BoJ regularly buys set amounts of government bonds from the secondary market on scheduled dates, but it can act at any time. The last time it stepped in unannounced was during the height of the pandemic in March 2020, when the benchmark yield surged about 30 basis points in 10 days.
Given that inflation remains far below the central bank’s 2% target and wage growth is subdued, a shift in policy doesn’t seem imminent, though market expectations look to be shifting.
“Investors’ target levels may be rising a bit, such as 0.1% to 0.2% for 10-year yields from between zero and 0.1% previously, and the 30-year closer to 1%,” Mitsubishi UFJ’s Ms. Muguruma said.
This method lets the BoJ buy unlimited amounts of debt at pre-determined yields. If it decides to do so for consecutive days, it is expected to announce details of the operation ahead of time.
Some strategists say the BoJ will likely to resort to this before the 10-year yield rises to 0.25%, unlike in July 2018 when it stepped in after the yield rose above the 0.10% limit allowed back then.
“Unscheduled bond operations could just encourage market participants to speculate the BoJ will keep buying, so they aren’t very effective,” said Eiji Dohke, chief bond strategist in Tokyo at SBI Securities Co. in Tokyo. “The BoJ is more likely to use the fixed-rate operation. It could offer to buy 10-year notes at 0.25% when the yield in the secondary market is around 0.22% to 0.23%.”
While such a level below the market price of the bonds would be unlikely to generate any takers, it would mark a line in the sand for the BoJ and could ease the upward pressure on yields.
Alternatively, the BoJ could use its scheduled buying operations to adjust the shape of the yield curve if it sees distortions, said Mari Iwashita, chief market economist at Daiwa Securities Co.
The BoJ has abandoned its monthly purchase schedule in favor of a quarterly plan since July, where it announces fixed amounts for each maturity with set dates for the operations. The next plan will be released on March 31.
“The BoJ could flexibly change the amounts during a month if needed, if it sees some issues in yield levels after conducting fixed-rate operations,” said Ms. Iwashita. If necessary, the BoJ could decide to change the amount or frequencies for the April-June quarter, she added.
Japan’s bond yields look unlikely to drop back to levels seen late last year, given the aggressive pricing for rate hikes by the Federal Reserve and European Central Bank, according to strategists.
Furthermore, markets may factor in a potential policy shift after Mr. Kuroda’s term ends in April 2023, said Eiichiro Miura, general manager of the fixed-income department at Nissay Asset Management Corp.
“Even if the 10-year yield is contained by BoJ operations, super-long sectors will remain volatile as investors won’t rush to buy when there is potential for a future change in BoJ policy,” he said. — Bloomberg