Overnight, the Bank of Japan surprised everyone by raising the limit on 10-year Japanese government bond yields. This made bonds and stocks sell off all over the world.
The central bank surprised the markets by changing its yield curve control (YCC) policy to let the yield on the 10-year Japanese Government Bond (JGB) move 50 basis points on either side of its 0% target, up from 25 basis points before. This was done to soften the effects of long-term monetary stimulus measures.
In a policy statement, the BoJ said that the goal of the move was to “improve the way the market works and encourage a smoother formation of the entire yield curve while keeping financial conditions favorable.”
After a long period of economic stagnation and very low inflation, the central bank implemented a way to control the yield curve in September 2016. The goal was to bring inflation up to the 2% goal.
The Bank of Japan (BoJ), different from most major central banks, kept its benchmark interest rate at -0.1% on Tuesday and promised to buy a lot more 10-year government bonds, keeping its ultra-loose monetary policy. On the other hand, other central banks around the world are still raising rates and tightening monetary policy in a strong way to try to stop sky-high inflation.
The change to the YCC made the Japanese yen and bond yields worldwide go up while stocks in the Asia-Pacific region went down. On Tuesday afternoon, the Nikkei 225 was down 2.5%. The yield on 10-year JGBs briefly went over 0.43 percent, its highest level since 2015.
The yield on the 10-year note went up by about 7 basis points to more than 3.66%, and the yield on the 30-year bond went up by about 9 basis points to 3.7%. Prices move in the opposite way of yields.
At the start of trading, shares in Europe also went down. The pan-European Stoxx 600 lost 1%, but then it rose again. European government bonds also went down in price. For example, Germany’s 10-year bund yield went up by almost 9 basis points to 2.2840%.
‘Testing The Water’
“The decision is being seen as a way to test the waters for a possible withdrawal of the stimulus that has been pumped into the economy to try to boost demand and wake up prices,” said Susannah Streeter, a senior investment and markets analyst at Hargreaves Lansdown.
“But the Bank is sticking with its bond-buying program, saying that this is just a matter of fine-tuning and not the start of a policy change.”
Mizuho Bank said in an email on Tuesday that the market moves are due to a sudden rush of bets on a hawkish policy shift from the BoJ. However, the bank said that just because this is a popular bet, it doesn’t mean that this is the policy’s reality or intended perception.
Vishnu Varathan, head of economics and strategy for the Asia and Oceania Treasury Department at Mizuho, said, “Fact is, there is nothing in the move or the accompanying statement that challenges our fundamental view that the BoJ will adjust policy to relieve JPY pressures but not become overtly hawkish.”
“For one, every effort was made to stress that policy accommodation is being kept, whether this was a reference to the planned and possible step-up in bond purchases or a suggestion that there won’t be any more YCC target band expansion (for now).”
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Spikes in volatility
In its statement, the Bank of Japan said that since early spring, market volatility around the world had gone up, which has significantly affected Japan’s markets.
“The way bond markets work has gotten worse, especially in terms of how interest rates on bonds with different maturities compare to each other and how arbitrage works between spot and futures markets,” it said.
The BoJ has expanded its band on yield curve control to 0.50%
This matters for ALL markets
The US. 10-year yield is up another 10 bps from Monday's close (up 20 bps for the week, and it is still Monday night!)
S&P (ES) futures -0.90%, below Mon low.
A quick 🧵to explain
— Jim Bianco biancoresearch.eth (@biancoresearch) December 20, 2022
The central bank said that if these market conditions stayed the same, it could “hurt financial conditions like how corporate bonds are issued.”
Luis Costa, head of CEEMEA strategy at Citi, said on Tuesday that the move in the market might be an overreaction. He told CNBC that the BoJ’s decision was “absolutely nothing shocking.”
“You have to look at this BoJ move in the context of how the dollar-yen exchange rate was set up before this change. “It’s just a change,” he said.
A Reuters poll from last week shows Japan’s annual inflation is expected to reach 3.7% in November. This would be the highest level in 40 years but still much lower than in comparable Western economies.
Costa said that the Bank of Japan’s move was not meant to fight inflation but rather to fix the “infrastructure and dynamics of JGB trading” and the difference in volatility between JGB trading and the rest of the market.
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