How the Bank of Japan took on the bond vigilantes and won, for now

The Bank of Japan showed investors last week just how tenacious it would be in keep interest rates locked in near zero in the world’s third largest economy despite soaring inflation around the world and the risk of weakening the yen to damaging levels.

The country was the epicenter of the market drama after the Bank of Japan launched a four-day unlimited deal. government bond buying spree on March 28 to prevent a drop in global debt that threatened to open its iron grip on yields.

The move sent the yen plummeting to its lowest level since 2015, prompting a flurry of comments from officials and a face-to-face meeting between BOJ Governor Haruhiko Kuroda and Prime Minister Fumio Kishida.

While some say that the BOJ can consider its historic intervention in the market a success, others argue that it has just bought a small breathing space before the pressure mounts again.

tensions rise

Tensions had been building during March. While rising inflation in other parts of the world prompted policymakers to cut stimulus and raise interest rates, the BOJ stood out with its commitment to keeping them on the floor.

Haunted by decades of minimal price appreciation, the central bank had signaled that it was less willing to budge until it became convinced that a the reactivation of inflation was sustainable. But that had traders betting his yield-curve-control policy couldn’t contain the market as the rest of the world raised rates to fight inflation.

Comparisons were drawn to the Reserve Bank of Australia’s efforts to cap yields, which were summarily abandoned in November after weeks of market pressure, a shock victory for the so-called bond watchdogs now stalking Japan.

After a surge in yields in February, the BOJ was forced to step in with a fixed-rate trade for the first time since 2018. It announced a one-day offer to buy an unlimited number of 10-year bonds, countering weeks of speculation. on policy standardization.

The relief was short-lived. Ten-year yields resumed their climb towards the limit tolerated by the BOJ: 25 basis points above zero. And hedge funds continued to aggressively short the yen, which had come under renewed pressure after Russia’s invasion of Ukraine raised concerns about Japan’s dependence on imported oil.

When the BOJ unleashed its fixed-rate buying spree on Monday, investors sent a response message: “Go ahead,” pushing yields even higher, to the 0.25% red line.

standing firm

But Japanese politicians showed no signs of cracking. The BOJ followed up unlimited buying on Monday with a three-day plan to buy even more from Tuesday, the first time it has intervened for such a long period.

“The BOJ waited until the last minute to do that fixed-rate trade out of concern about the impact of a weak yen on its action,” said Yasunari Ueno, chief market economist at Mizuho Securities.

After announcing extended buying, a sign that the BOJ is not giving up on low rates, the yen tumbled to the 125 yen per dollar level as the currency became the favored option to trade the spread. of increasing rates between the United States and Japan.

That level is also widely seen as Kuroda’s threshold for the coin to become bad for the economy, a sign that he can’t stick to that and limit returns at the same time.

The benchmark yield stood for most of Tuesday at 0.245% with traders and BOJ officials eyeing each other.

return point

The surge in bond buying in a variety of maturities, in addition to Wednesday’s fixed-rate trade, marked a turning point. And when the governor said the trades did not directly affect currency levels, the implication was that yields took precedence over the yen.

The central bank chief spoke after meeting Kishida in a token meeting that showed the leaders were on the same page.

The decision to put longer-dated bonds on its emergency buying list, an area of ​​the curve nominally outside the BOJ’s control, was another crucial move that pushed back a rise in 30-year yields. That was a sign that Kuroda had the stomach to do more than just target 10-year yields.

With its massive interventions on Wednesday, the BOJ managed to regain control of the 10-year yields, sending them below the 0.25% target. Within three days he had bought a total of 2.9 trillion yen ($23.7 billion) worth of bonds.

“Once they decided to move, they were unstoppable,” said Ueno. “The contrast between his hesitation before and his determination afterward was dramatic and we saw the climax of that this week.”

quiet thursday

The central bank underscored its point on Thursday with a quarterly bond-buying plan that saw a modest increase in purchases of various maturities.

Investors were reminded that the BOJ has purchased much larger amounts of debt under Kuroda’s watch. In 2015, net purchases exceeded 80 trillion yen compared to 13.5 trillion yen last year, an indication that the bank still has plenty of money on hand.

“When I saw their quarterly plan, I got the impression that they were still withholding a big raise until it was really needed. They used to buy 7 trillion yen or 8 trillion yen a month and the latest plan is nowhere near that,” said Makoto Suzuki, senior bond strategist at Okasan Securities. “I don’t see the BOJ losing this battle to keep yields down.”

Bond markets and the yen calmed down later. Benchmark yields had slipped as low as 0.20% and the currency stabilized around 122 yen against the dollar, no doubt with some help from global market moves.

temporary respite

Still, some warn that it may only be a temporary reprieve.

Clinging to control of the yield curve will be “unsustainable if we find ourselves in an environment of high inflation and rising rates in other economies,” said Zach Pandl, co-head of global currency and emerging markets strategy at Goldman Sachs Group Inc., on Bloomberg. Television.

And currency experts expect more pressure on the yen.

Kit Juckes, who has nearly four decades of experience in the market, believes short yen bets have room to work. “If weak yen trading becomes popular, and the BOJ doesn’t care, there is plenty of room for it to grow,” Juckes, a strategist at Societe Generale SA, wrote in a note.

Thierry Wizman of Macquarie Futures said the inevitable arrival of inflation in Japan will force the central bank to raise the ceiling on yields.

“As long as the BOJ continues its super-accommodative monetary policy and yield curve control while other central banks become more aggressive with built-in inflationary pressures, the yen is likely to suffer,” said Amir Anvarzadeh, Strategist at Asymmetric Advisors PTE. . “This is a war the BOJ is going to lose.”

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