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The Japanese government bond market has been the scene of some excitement in markets recently.
That’s not a sentence I have to type very often.
We’ll go into it in more detail below, but in a nutshell, investors don’t believe that the Bank of Japan (BoJ) can stick to its promises. The BoJ begs to differ.
Who’ll be the winner? And what does it mean for your money?
The thrills and spills of the Japanese government bond market
In September 2016, the Bank of Japan (BoJ) – a serious monetary policy innovator – decided to peg the yield on the ten-year Japanese government bond (JGB) at around 0%. In practice (so far), that means it won’t let the JGB yield rise above 0.1% or so.
In other words, if the yield on the ten-year JGB rises to above 0.1%, then the BoJ prints money and buys as many bonds as it takes to get the yield back down. Alternatively, if the yield turns negative, the BoJ will sell bonds to get the yield back up.
This policy is known as “yield curve control”. It’s gone beyond quantitative easing (QE) to the next logical step, which is price-fixing, pure and simple.
This decision was taken at a time when all the pressure on bonds was still for yields to fall. The BoJ didn’t want the yield on the ten-year to fall below 0%, because that would suggest that its war on deflation had been lost. Simply printing even more money would have risked the market shrugging its shoulders and saying “so what?”
It was a clever call. While most central banks were trying to figure out whether to extend or cut back on QE, the BoJ just cut straight to the heart of the matter. It said: “We’ll do what’s necessary to keep that yield at 0%. You can challenge that if you want, but we’re the ones who have complete control over supply and demand.”
Put like that, markets just went with it – they had, after all, no other option.
Yet in the last week or so, that’s changed. The BoJ has been challenged. Yields on the ten-year have risen (in other words, prices have fallen as investors have sold out). This has forced the central bank to intervene to drive them back down, on no less than three occasions.
To be clear, as Marcus Ashworth notes on Bloomberg, the BoJ has only had to threaten intervention four times since the policy was introduced. And it only actually had to buy bonds on one of those occasions.
However, it’s now becoming clear that the pressure is on global yields to rise. Investors are starting to think that the BoJ’s policy is unsustainable. The Japanese economy might not be seeing a lot of inflation but it is doing pretty well.
It’s operating at full employment (in fact, employment is arguably even higher than that, in terms of what economists would have considered to be full employment).
As a result, there have been whispers that the BoJ was thinking of changing policy, to allow yields to rise further. One argument is that this would enable banks to improve their profitability (banks make money by borrowing over the short term to lend over the long term, so in effect, the bigger the gap between short-term bond yields and long-term ones, the more money they make).
So investors had started to take bets on a big shift at today’s BoJ monetary policy meeting.
Turns out they were wrong.
Make no mistake – the Bank of Japan has tightened policy (a little)
The BoJ shows no signs of backing down. Instead, it slightly widened the trading range of the ten-year yield – it’ll now be allowed to rise to 0.2% (or fall to -0.2%) before the BoJ intervenes.
BoJ boss Haruhiko Kuroda emphasised that this is a technical shift to enable the bond market to function properly, note Mark Williams and Marcel Theliant at Capital Economics. The BoJ made sure that everyone knows that it will keep interest rates at current levels “for an extended period”. He also emphasised that improving bank profitability is not one of the BoJ’s goals.
However, that said, a rise is a rise. In effect, the BoJ has gone from capping yields at 0.1% to capping them at 0.2%. I’m not sure that’s easily dismissed. It’s a tiny move but it is in effect, a very, very small hike in rates.
Sure, it’s very tentative, and Kuroda, as the Capital Economics note makes clear, was at pains to emphasise that this isn’t a step on the road to much tighter monetary policy – particularly given the fact that inflation in Japan still remains stubbornly miles away from the 2% target.
But if we’re wetting ourselves over 0.25% rises in the UK and the US, then a 0.1% rise in Japan is probably worth noting.
The market didn’t seem entirely sure how to react. And given that the BoJ is still prepared to keep funnelling cheap money into the global financial system, this hardly kicks the legs out from under the market. And I’d certainly stick with Japanese equities.
But as with every other central bank these days, the focus is now on how monetary policy can get tighter without blowing things up. And as I said in yesterday’s Money Morning, that’s already having an effect on global housing markets. It’ll be interesting to see what starts to struggle next.