Japanese bonds took another hit in a test of the central bank’s resolve to cut interest rates

Japanese government bond prices fell for the second day in a row as markets vigorously challenged the central bank’s assertion that it does not plan to raise interest rates.

Japan’s usually quiet government bond yields rose on Tuesday, sending shockwaves through global debt markets, after Bank of Japan Governor Haruhiko Kuroda surprised investors in his final months in office by overhauling the way the central bank keeps a lid over the long term. borrowing costs. “This measure is not a rate hike,” Kuroda said. “Adjust [yield curve control] not pointing . . Exit strategy.

But on Wednesday, yields continued to rise, with the benchmark 10-year yield coming in at 0.5 percent — low by global standards but substantially doubling since the beginning of this week and the highest point since mid-2015. The pressure on debt suggests investors think they can see The beginning of the end of Japan’s six-year experiment with negative interest rates and yield targeting.

“We all know this is a step in that direction,” said Mark Dowding, chief investment officer at BlueBay Asset Management, as his long-term negative bet on Japanese government bonds this week brought big returns. “The genie is out of the bottle for markets which are likely to bring about further changes in policy.”

On Tuesday, the central bank said it would allow 10-year bond yields to fluctuate 0.5 percentage points above or below its target of zero, replacing the previous range of 0.25 percentage points. Japan has kept long-term yields low since 2016 and the previous range has been in place since 2021 in an effort to revive long-dormant inflation.

Line chart of the 10-year government bond yield (%) showing the selling of long-term Japanese bonds

Kuroda, who will step down as governor in April, denied the revision represented a tightening of monetary policy, saying the Bank of Japan was determined to ease further if needed to meet its 2 percent inflation target.

But that message didn’t pan out, especially since core inflation — which excludes volatile food prices — recently exceeded the Bank of Japan’s target for the seventh straight month, hitting a 40-year high of 3.6 percent in October.

“The bond market is already starting to price in as the Bank of Japan will steadily head towards the end of the monetary easing program with a conservative change [in April]said Takeshi Yamaguchi, chief Japan economist at Morgan Stanley. “No matter how much Kuroda says that this is not a rate hike and that easing measures are being strengthened, no one believes him. It is a credibility issue.”

The central bank sought to match its rhetoric about sticking to an easy monetary path with actions. In addition to expanding the 10-year yield range, it also boosted monthly JGB purchases from 7.3 trillion yen to 9 trillion yen ($68 billion) and introduced a broader range of unlimited bond buying. Some analysts say this sends the right message.

“This is not a turning point in the Bank of Japan’s policy,” said Kazuo Momma, former head of monetary policy at the Bank of Japan and now executive economist at Mizuho Research Institute. “If the market function improves, it will be a one-time measure.”

Moma said the BoJ’s decision was based in part on a bond market survey conducted in November that showed market conditions had deteriorated to the worst level in 15 years. The central bank now owns more than half of the bonds outstanding. On some days, no bonds are traded at all – a sharp contrast to other major bond markets in the US and Europe where billions are traded daily.

Traders have long complained about this frozen liquidity. But they say the timing of Kuroda’s efforts to soften the market’s performance, at a time when inflation is accelerating and other central banks are rapidly raising interest rates, points to a larger shift. Analysts say they are likely to test the central bank’s ability to stick to its new volatility limits.

The Bank of Japan may have to make a decision [further] “If market players especially outside Japan don’t believe Kuroda’s statements and continue shorting Japanese government bonds,” said Keiichi Murashima, an economist at Citigroup. He added, “One of the important tasks of the new governor is to restore the low credibility of the Bank of Japan and rebuild communication with the markets.”

Moma of Mizuho and Yamaguchi of Morgan Stanley say the Bank of Japan could eliminate yield curve controls under the new ruler next year, but the hurdle to raising interest rates will be higher due to global economic pressures.

“The next policy decision by the BoJ is likely to be a major one – such as changing long-term or short-term interest rate targets or ending YCC altogether, and this will depend on the risks of a global economic slowdown in 2023,” said Nauhiko Baba. , chief Japanese economist at Goldman Sachs, indicating that the central bank could abandon its negative interest rate policy.

Additional reporting by Katie Martin

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