Following a week of historic rate hikes and aggressive moves by the Federal Reserve and other major central banks, the Bank of Japan has hardly ever seemed more like a rebel standing athwart the consensus.
And after its two-day policy meeting Friday, the BOJ, as expected, left interest rates at ultraloose levels, despite a plunging Japanese yen.
Unfortunately for some investors, the BOJ’s refusal to accede to the market’s demands has come at a price. And judging by recent market ructions in the dollar-yen currency pair
(which were sinking in Friday trading) and the market for Japanese government debt — which the BOJ has long backstopped with seemingly bottomless bid — it looks like the central bank has found itself entrenched in a battle with foreign speculators, analysts said.
Despite the central bank ramping up its bond-buying earlier in the week, Japanese government bonds, particularly at durations below the 10-year mark, have seen yields, which move opposite of prices, surge.
The selloff cooled on Thursday as the Bank of Japan’s two-day policy meeting got under way, and yet, the damage has largely been done. Bloomberg reported that the Bank of Japan could face “huge losses” on its $4 trillion trove of government bonds should it abandon its easy money policies.
What’s more, the hope among economists and market participants that the Bank of Japan might make a slightly dovish adjustment to its policy of yield curve control caused markets to whipsaw — the dollar-yen currency pair
on Thursday appeared headed for its largest two-day correction since March 2020.
Jens Nordvig, the founder and CEO of Exante Data and a longtime currency market guru, noted via Twitter that the scramble to hedge against a more assertive tone from the Bank of Japan has been quite intense.
As far as what that shift might look like, analysts at Japanese banks have been eerily silent, and economists and market strategists looking on from abroad have ventured to speculate that BOJ Gov. Haruhiko Kuroda and his team might eventually ease up on the acceptable yield ranges for JGBs — although there seems to be wide agreement that any kind of substantial move on the central bank’s part on Friday would be extremely out of character.
When it does arrive, it’s possible that the move could look like a widening of the central bank’s acceptable range for the JGB yields for bonds and bills of the shortest maturity through the 10-year. But even this seems relatively modest when viewed in the context of what the rest of the world’s central banks — with the Federal Reserve front and center — appear to be doing.
The surge in JGB yields appears to have abated (at least, for now), and the dollar has staged a notable reversal, weakening more than 2% against the yen Thursday in what was its biggest two-day drop since March 2020. But analysts say the fact remains that the state of the Japanese 10-year yield curve signals that investors are ready to duke it out with the BoJ, as the bank has been buying trillions of dollars’ worth of bonds just to maintain the status quo. If it persists at the current rate, it will have bought some 10 trillion yen (worth some $75 billion) in June.
“This is a truly extremely level of money printing,” said Deutsche Bank’s George Saravelos.
What’s at stake?
Saravelos warned that if confidence in the BOJ’s ultraloose policy gives way, the result could be chaos in Japanese stocks and equities.
“If it becomes obvious to the market that the clearing level of JGB yields is
above the BoJ’s 25 basis point target, what is the incentive to hold bonds any more?” Saravelos said. “Is the BoJ willing to absorb the entirety of the Japanese government bond stock?”
“Where is the fair value of the yen on this scenario and what happens if the BoJ
changes its mind?” he said.
But it’s not just Japan that will be affected — far from it. Analysts said ripples could spread through stock and equity markets across Asia, and perhaps Europe and the U.S. as well.
Further strength in the U.S. dollar accentuates market sensitivities across the world by making life more difficult for emerging market corporations and governments to service their debt. It’s one reason why the rate hiking cycles can sometimes help provoke problems like the “Tequila Crises” of 1994.
Of course, the Bank of Japan wouldn’t want a replay of that either.
How did we get here?
Fortunately for the Bank of Japan, markets are getting a bit of reprieve on Thursday with the weak U.S. economic data coming just before their big rate decision, according to Steve Englander, FX strategist at Standard Chartered Bank.
U.S. jobless claims lingered near five-month highs last week, and housing starts signaled that trouble could be brewing in the U.S. real-estate market (both of which could be construed as positive developments on the Federal Reserve’s agenda).
Japan and the BOJ fought for years to try to push inflation higher and return the Japanese economy to a state of more dynamic growth. Unfortunately, a slew of factors, including demographic issues, has held it back.
Now, the BOJ needs to find the sweet spot where it can accommodate investors demanding a dramatic policy shift, while also not ceding 100% of the control over the narrative to speculators and bond vigilantes.
“The problem with that is once you let go a little bit, the market anticipates that you will let go a lot,” Englander said. “Until you get to a level where the market says ‘this looks reasonable’ they’re going to be facing that pressure.”