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BOJ Policy Change Speculation Roils Markets

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BOJ Policy Change Speculation Roils Markets

  • Central bank’s offer to buy unlimited bonds drew no sellers
  • Yield curve bear-steepens before 40-year debt sale on Tuesday
The BOJ’s policy changes may take "much longer" than expected, according to UBS’s Yianos Kontopoulos.

A dramatic day for Japan’s debt market saw yields surge on media reports of possible changes to the nation’s ultra-loose monetary policy, spurring the central bank to offer to buy an unlimited amount of bonds.

The yield on 10-year government securities soared as much as six basis points to 0.09 percent, its biggest increase in almost two years, pulling the yen higher and weighing on stocks. While the yield came down after the purchase offer by the Bank of Japan, it then bounced back to just one basis point below the day’s high.

Any change to BOJ’s stimulus would be the first since 2016 when it introduced control of the yield curve in a bid to manage the impact of its bond purchases and negative interest rates. Still, profits for banks and bond traders continue to be depressed, with reports from Reuters, Asahi and Bloomberg suggesting that officials are debating ways to further mitigate the side effects.

"The BOJ stepped in to hold a fixed-rate operation to make sure the market won’t be driven further by the speculation,” said Shinji Hiramatsu, general manager at the fixed-income investment department of Sompo Japan Nipponkoa Asset Management Co. in Tokyo. It won’t be easy for the central bank to wind back its stimulus policy as it may boost the yen and push down stock prices, he said.

The BOJ’s offer to buy an unlimited amount of bonds on Monday was meant to meet its policy objective of keeping 10-year yields at around zero percent, an official at the financial markets department said. Its offer to buy the note at 0.11 percent wasn’t met with any sellers.

The yen climbed as much as 0.6 percent to 110.75 per dollar, before paring the advance to trade at 111.00 at 4:20 p.m. in Tokyo. The currency’s strength was also compounded by a dollar sapped by U.S. President Donald Trump’s accusations on Friday that other countries have manipulated their exchange rates.

Yen strength would probably be capped at 108 to 109 even if the BOJ tweaks its policy to allow the 10-year yield to rise, wrote JPMorgan Chase & Co. strategist Tohru Sasaki.

“The BOJ will likely emphasize in its communication that allowing JGB 10-year yields to rise higher than 0.10% is adding a mere flexibility to the monetary policy, and it is not a tightening,” the strategist wrote.

Kuroda’s Dilemma

The dilemma for Governor Haruhiko Kuroda is that even as calls to change policy grow louder, persistently weak inflation dictates the need to maintain stimulus. Winding it back would strengthen the yen, further undermining efforts to spur higher prices, while also hitting Japanese exporters.

While Kuroda and his board did say they would consider discussing an exit from the stimulus policy from fiscal 2019, they have also said persistently that there would be no change until an inflation target of 2 percent has been reached.

“I know absolutely nothing about the basis for those reports,” Kuroda said when asked about speculation while he was in Buenos Aires to attend a meeting of finance ministers and central bank governors.

Bloomberg’s reporting indicates that officials are focused on coming up with adjustments to mitigate harm without doing anything resembling a move to policy normalization. At this stage, there’s little likelihood of a significant change on July 31 to yield-curve control or asset-purchase settings, said officials involved in discussions, who asked not to be identified because the talks are private.

‘Trial Balloon’

According to Reuters, ideas to mitigate policy harm include tweaking the yield-curve control program to allow for a more natural increase in long-term interest rates, and operational changes to the way the BOJ buys JGBs and exchange-traded funds. The report said discussions were preliminary and outcomes would be dependent on inflation forecasts.

The news reports may be a “a trial balloon, aimed partly at signaling policy won’t be on autopilot forever,” Bloomberg Economics’ Yuki Masujima wrote. “We expect the BOJ to raise its target for the 10-year yield by a small increment from around 0 percent now around October, assuming key conditions are met: core inflation is above 1 percent, the yen is stable, and Prime Minister Shinzo Abe makes a symbolic declaration that deflation is over.”

The fixed-rate operation on Monday is the fifth since the introduction of the yield-curve control policy in 2016, with only the one in February 2017 leading to actual purchases.

The sovereign curve bear-steepened, with 40-year yields up 10 1/2 basis points to 0.910 percent. The Ministry of Finance will auction 400 billion yen ($3.6 billion) of this tenor on Tuesday.

“The curve steepening is driven by hedge selling into the 40-year bond auction,” said Tadashi Matsukawa, head of fixed-income investment at PineBridge Investments Japan Co. “Such a move makes reactions in the bond market even bigger.”

— With assistance by Chris Anstey, and Masahiro Hidaka