Long-term Japanese government bond yields and the yen surged on Friday as markets increased pressure on the central bank to further adjust a core tenet of its ultra-loose monetary policy.
Analysts said the sharp moves underscored deepening dysfunction in the market for Japanese government bonds over the past month and raised uncertainty ahead of the Bank of Japan’s policy board meeting next week.
Traders in Tokyo described the widening range of possible outcomes from the two-day event as “brutal” for investors accustomed to a decade of predictability under governor Haruhiko Kuroda’s quantitative easing programme.
The central bank revised its longstanding yield curve control measures last month, vowing to restore order to the market for Japanese government bonds, which had been distorted by the BoJ’s bond-buying programme.
Instead, the YCC tweak — widening the range in which the bonds can fluctuate — has produced more volatility in recent weeks, challenging the BoJ to further revise its policy.
The 10-year bond yield briefly rose above 0.53 per cent after the market opened in Tokyo on Friday, breaking the new ceiling of 0.50 per cent set by the BoJ and reaching the highest level since June 2015. The yen hit 128.66 against the US dollar, its highest in more than seven months.
Takeshi Yamaguchi, Japan chief economist at Morgan Stanley, said the YCC framework created by the BoJ could be viewed as a game between the central bank and markets, which depended on investor confidence in the system.
“The sudden change in December may have damaged market participant confidence in BoJ communication and YCC sustainability,” Yamaguchi said.
“If many market participants expect elimination of the YCC framework at time, this situation is likely to accelerate JGB selling and worsen market functioning before then,” he said.
Citigroup economist Kiichi Murashima forecast that Kuroda would abolish the BoJ’s longstanding yield curve control measures when bank policymakers meet on Tuesday and Wednesday.
“The dysfunction of the JGB market over the past month seems worse than expected, so it seems logical that further policy adjustment may have become inevitable,” he said. “The BoJ may not have expected conditions to get this bad, but they’re now held hostage to their own logic that they would act to improve market functioning.”
For Kuroda, next week’s monetary policy meeting will be the second to last before he steps down in April. That has also fuelled market speculation that he will end the YCC framework to smooth the transition to his successor.
On Tuesday, Japan’s Yomiuri Shimbun newspaper reported, without attribution, that the BoJ would review the side-effects of its YCC framework and make additional policy adjustments if needed.
The BoJ stunned markets in December by announcing that it would allow 10-year bond yields to fluctuate by 0.5 percentage points above or below its target of zero, replacing the previous band of 0.25 percentage points. It kept overnight interest rates at minus 0.1 per cent.
Since then, markets have challenged Kuroda’s assertion that the central bank was not tightening its monetary policy, forcing the BoJ to spend tens of trillions of yen in unscheduled government bond purchases to control a jump in yields.
“Bond yields and the yen rose while shares have fallen. There is no way that this was not a tightening,” said Masamichi Adachi, UBS’s chief economist in Japan.
Still, he added that it was unlikely the BoJ would take bolder steps to tighten its policy unless there was a material change in Japan’s inflation outlook and evidence of acceleration in wage increases.
The country’s core inflation, which does not include volatile fresh food prices, hit 3.7 per cent in November, its highest in nearly 41 years.
Some big companies such as Fast Retailing, owner of Uniqlo, have unveiled substantial wage increases, but economists remain divided on whether such moves will be sustained enough to create a cycle of rising wages, consumption and prices.
Naka Matsuzawa, chief Japan macro strategist at Nomura, said the BoJ was unlikely to make any changes to its policy next week.
“The short-term JGB markets are pricing in not only the end of negative interest rates but additional rate hikes,” Matsuzawa said. “If markets are being distorted by speculative bets, based on incorrect policy assumptions, the BoJ will need to firmly fight against that.”
