The Bank of Japan appears to have reached a truce with bond traders who are betting it will have to abandon its efforts to control yields on government debt, as an expanded bank lending program helps ease the relentless recent squeeze on Japan’s bond market.
After more than a month of battling huge speculative bets by hedge funds with record purchases of government bonds, the BoJ decided last week to maintain the main pillars of its ultra-loose monetary policy and signaled no plans to abandon so-called yield curve control. The central bank also expanded a critical lending tool, a measure that helped the recovery of Japanese government bonds.
As part of the extended lending program, the BoJ will offer banks loans of up to 10 years at variable rates, instead of the previous fixed rate of zero percent.
Analysts say banks are likely to return some of this money to the bond market, which would help stabilize the yield curve. In Monday’s first auction for five-year funds, the BoJ received bids totaling 3.13 trillion yen ($24 billion), three times the amount offered, with an average yield of 0.145 percent of successful bids.
“Markets are responding favorably to this program and bids have settled at the right level with an average rate of 0.145 percent, suggesting that banks will continue to participate in the next auction,” said Takenobu Nakashima, chief interest rate strategist at Nomura. “This increased the chances that yield curve control would be sustainable.”
During the BoJ’s battle with markets in early January, interest rates on Japan’s benchmark 10-year government bond rose above the central bank’s target limit of 0.5 percent, boosted by traders who believed they could force outgoing governor Haruhiko Kuroda to withdraw his signature policy. .
Since Kuroda remained firm after the bank’s monetary policy meeting last week, Japan’s 10-year yield fell to a low of 0.36 percent. It traded near that 0.38 percent level on Monday after the BoJ carried out its first expansionary lending operation.
Kazuo Momma, the former head of monetary policy at the BoJ, who is now executive economist at the Mizuho Research Institute, said that turning to the credit scheme is usually reserved for periods of poor liquidity, such as after the Covid-19 pandemic or the global financial crisis, the BoJ wanted to show that it is prepared to take unprecedented steps to control the yield curve.
“It’s a clear message that the BoJ will continue with its monetary easing measures, showing that it is prepared to go this far,” Momma said.
He added that the BoJ needed to strengthen its communication with markets after it stunned investors in December by saying it would allow 10-year bond yields to vary by 0.5 percentage points above or below the zero target, replacing the previous range of 0. 25 percentage points.
Since then, investors have disputed Kuroda’s claim that the move was not a tightening of monetary policy.
But analysts said it was unclear how long the détente would last and whether the central bank’s latest move to boost its funding operations would be enough to restore stability to Japan’s government bond market. If last week’s decision made anything clear, according to one analyst, it’s that the future of yield curve control policy is now in the hands of Kuroda’s successor as of April.
Hideyasu Ban, a banking analyst at Jefferies in Tokyo, said the BoJ’s large purchases of Japanese government bonds since it began controlling the yield curve in 2016 had left it owning about half the market, limiting the scope for banks to increase their holdings.
That’s why they are more likely to look for arbitrage opportunities in the swaps market, where interest rates have recently risen well above government bond yields as investors anticipated a tightening of monetary policy, Ban said. The BoJ’s move, he said, was about the central bank giving itself more flexibility in controlling the pace of rising yields.
“We basically see it as buying more time, mainly through the announcement effect,” said Naohiko Baba, Japan economist at Goldman Sachs.
Tohru Sasaki, chief forex strategist at JPMorgan, said the BoJ’s decision last week showed its concerns were still more tilted towards the risk of deflation than higher inflation.
Because it may take time to disprove that thesis, he said, the BoJ was actually committed to buying huge amounts of government bonds on top of the colossal purchases in December and the first half of January.
It is clear that the improved funds supply operations were aimed at lowering long-term rates, Sasaki added, but it is not clear whether this will be effective.
“If the BoJ continues to buy Japanese government bonds at this pace, the BoJ’s stake is likely to reach 60 percent by mid-year,” he wrote in a note. “The longer they keep control of the yield curve, the harder it will be to get out.” . . there is no way out of this swamp.”