After government bond markets around the world were rattled by talk of a potential policy shift by the usually predictable Bank of Japan, investors are likely to pay close attention to its July 30-31 policy meeting.
News reports earlier this week indicated policy makers would discuss tweaks designed to make their extraordinary stimulus measures more sustainable. That stirred expectations the central bank could start moving away from its ultra-accommodative policy stance and sparked a temporary selloff in government paper in Japan, Germany and the U.S.
“There’s more market significance in the BOJ meeting than there’s been in a while,” said James Athey, senior investment manager at Aberdeen Standard Investments.
The central bank was often largely ignored by market participants who see it as a relative laggard in normalizing monetary policy compared with its peers at the European Central Bank, who plan to wind down their monthly asset-buying program in December, and the Federal Reserve, which has embarked on a series of rate increases and is shrinking its balance sheet. Ultralow interest rates in Japan and Europe are credited with pushing investors out of their domestic bond markets into higher-yielding markets.
The prospect of a debate on how to tweak the BOJ’s trademark yield-curve control policy, which aims to keep the 10-year Japanese government bond yield TMBMKJP-10Y, +3.66% near 0%, have exerted pressure on the Japanese bond market, sparking the 10-year yield’s largest one-day jump in two years on Monday. The 10-year yield for Japanese government bonds, or JGBs, currently sits at 0.10%, at the upper edge of its trading range, according to Tradeweb data.
Inflation, however, remains well below the central bank’s target of 2%, too low to justify a shift in monetary policy, some analysts say. So-called core-core Japanese consumer prices, which strips out food and energy, rose only 0.2% year-over-year in June, coming in below the consensus estimate of 0.4%.
“It’s very difficult to understand from an economic perspective of why now. Just purely from a notion of central bank as managers of the economic profile, it’s very strange. But underneath that, it’s more understandable,” said Athey.
See: This selloff in U.S. government debt will prove short-lived, Morgan Stanley says
Some market participants contend the Bank of Japan’s accommodative policies are no longer tenable because of their failure to stimulate inflation and the pressure they place on lenders’ profits. Moreover, investors worry the central bank’s debt purchases have drained liquidity from the government bond market. The BOJ now owns more than 40% of the total JGBs outstanding.
Yet Athey says the BOJ is not running into operational limits on its bond-buying. In fact, the BOJ’s yield curve control policy has drastically cut its need to carry out large bond purchases. By targeting a specific yield level instead of a monthly chunk of bond purchases, it dissuaded investors from attempting to short Japanese government bonds altogether.
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The BOJ aims to increase its JGB holdings by 80 trillion yen ($720.8 billion) a year. In April, its holdings of JGBs rose 48 trillion yen from a year earlier, around 40 percent less than what is suggested by the BOJ’s guidelines, according to the central bank’s data.
Read: Bank of Japan ending QE won’t unleash higher rates, strategist says
The chief concern for investors and the central bank is that Japanese financial institutions have seen slimming margins from borrowing short and lending long thanks to negative to ultralow interest rates. Commercial banks have lobbied against the Bank of Japan’s purchases of corporate bonds at negative interest rates as it could force them to lower the interest rates they charged to businesses, according to recent Bloomberg News reports. Falling bank profits could discourage lenders from issuing credit.
“Market participants, especially financial institutions, have expressed their concerns that the current easing framework is flattening the yield curve and affecting the strength of their businesses,” said Takuji Aida, chief Japan economist for Société Générale, in a Monday note.
There are also doubts whether ultra-easy monetary policy can stoke inflation in an economy that has struggled with falling prices in the past few decades. After several rounds of quantitative easing, inflation remains nowhere near the central bank’s target despite Bank of Japan Gov. Haruhiko Kuroda’s public confidence in the measures.
But in the face of tepid inflation, market participants may interpret any step toward winding down its easy money policies as the BOJ conceding defeat.
“If the BOJ were to promote higher yields under these circumstances, the course change could be taken as an expression of doubt in the effectiveness of its own accommodative policy, so the barriers are high,” said Shuichi Ohsaki, chief rates strategist at Bank of America Merrill Lynch, in a Friday note.
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