Maybe the Bank of Japan Thinks the Yield Curve Is Just Right
"I love you just the way you are," goes the 1977 Billy Joel single.
Bank of Japan Governor Haruhiko Kuroda may be humming a similar tune when it comes to the shape of Japan's yield curve, according to some analysts who have taken a contrarian view on the central bank's latest policy evolution.
In the wake of the BOJ's long-awaited policy decision, the consensus opinion among analysts is that monetary policymakers have thrown a bone to banks, who have complained that negative policy rates and low long-term interest rates pose an existential threat to their business models. The move to control the yield curve, in this view, is all about widening the spread between short and long term rates to enhance banks' profitability.
However, an alternate interpretation of the BOJ's statement and snippets of Governor Haruhiko Kuroda's press conference imply that there's no desire to have long term rates rise, other strategists assert.
The imposition of negative rates and flatness of the yield curve has drawn central banks to pay closer attention to how their policy actions affect the provision of credit, rather than just the demand for it. As such, conventional wisdom holds that the Bank of Japan's shift was an attempt to prevent suffering among entities engaged in the business of risk and maturity transformation, or simply, to steepen the yield curve.
The BOJ's comprehensive assessment touched on this theme, noting that "an excessive decline and flattening of the yield curve may have a negative impact on economic activity by leading to a deterioration in people's sentiment, as it can cause uncertainty about the sustainability of financial functioning in a broader sense."
The BOJ kept its policy balance rate at -0.1 percent, while pledging to keep the 10-year yield around zero percent.
This policy tweak may show that the BOJ is looking for a Goldilocks yield curve: one in which the spread between short and longer term rates isn't so wide so as to crimp the demand for credit for households and corporations, but not so small that it would provide and extreme disincentive for banks to lend.
What's unclear, as analysts digest the bank's communiques, is whether Japanese monetary policymakers think that this Goldilocks yield curve has already been achieved.
"In terms of the shape of the yield curve, Kuroda said at his press conference that the current yield curve seems about right," said Daiwa Capital Markets Head of Research Grant Lewis and Head of Economics Research Chris Scicluna. "So, we think, what they are trying to do is to keep the yield curve roughly where it is."
And that yield curve shape, from three-month to 10-year debt, is among the flattest it's been since Kuroda assumed control of the central bank — though the recent bond market sell-off has helped push it off its summer low.
As such, the Bank of Japan is really "committing to a flat yield curve," said Bespoke Investment Group Macro Strategist George Pearkes. "The gist [of the policy change] is that 'the Bank stands ready to conduct fixed-rate JGB purchase operations — for example, those with regard to 10-year and 20-year JGB yields — in order to prevent the yield curve from deviating substantially from the current levels.'"
The phrase "purchase operations" rather than "open market operations" is, the strategist says, a hint that the central bank is committed to keep the yield curve from getting steeper via an increase in longer-term interest rates.
"This is a flattener," he concluded.