Evening Brief – 10.30.23
Yield Curve (Out of) Control
With the Bank of Japan’s (BOJ) announcement on Tuesday already expected to be more exciting than either the Federal Reserve or the Bank of England later this week (both of which are expected to keep policy unchanged), the Japanese yen surged to its highest level in three weeks against the US dollar on Monday after Nikkei Asia reported that the central bank may tweak its Yield Curve Control (YCC) framework again and allow long-term yields to rise above 1%.
According to Nikkei, the BOJ is figuring out that it is stuck and must change its YCC again “potentially allowing 10-year Japanese government bond yields to rise above 1%.”
With the long-term interest rate currently set at 1%, the central bank has conducted limitless fixed-rate buying operations to keep rates below that level, smashing the yen and driving inflation considerably higher.
The report also noted that “the second framework tweak in three months appears to have been deemed necessary as 10-year (Japanese government bond) yields are approaching 1% amid a backdrop of rising US rates” and added that the “BOJ is also likely to more flexibly conduct its JGB purchase operations.
This, along with a more flexible cap on 10-year yields, is aimed at deterring speculators from targeting the upper limit and sparing the BOJ the need to buy droves of JGBs to keep rates under 1%.”
The report came after the 2-year JGB auction tailed the most since 2010, despite having a 10-basis point coupon for the first time in over two and a half years, as investors balked at the “opportunity” of buying long-term paper immediately before another significant tightening step by the BOJ.
“Current levels of 1.12% suggest JGBs will breach 1% following further YCC amendments, which we agree with,” wrote Ryoya Wakamatsu of Goldman’s FICC desk. In fact, depending on whatever option the BOJ chooses, we believe 10-year rates might range from 1.10% to 1.30%.”
Japan’s monetary policy rate is still about –10bps. The central bank is trying to normalize the front end. They’re dying on the vine, and the Japanese yen has gone from about 110 to 150 over the past several months. They’re between a rock and a hard place and playing with the front end can be very dangerous.
As Mohamed A. El-Erian, chief economic advisor at Allianz SE and former CEO of Pimco, poignantly noted on Bloomberg, “This development illustrates not just spillovers from US markets but also the material risk of adverse spillbacks to the US and markets around the world.”