BOJ Draws Line in Sand But Faces Battle to Cap Bond Yields

  • Battleground could shift to 2- to 5-year sector: MassMutual
  • Friday’s operation signals 0.11% is top for 10-year: Barclays

While the Bank of Japan faced down the market on Friday with its offer to buy an unlimited amount of bonds, the battle over yield control may have only just begun.

The swift action allowed the BOJ to quickly assert authority over the 10-year yield, bringing it down from a five-month high of 0.105 percent. The question is how far the central bank would have to go, and at what costs to its balance sheet, as the hawkish tilt adopted by its peers increases the extra yield offered by U.S. Treasuries and German bunds over Japanese bonds.

“It hinges on whether the BOJ can inspire confidence and establish credibility on its intent to hold yields,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd. in Singapore. “The option of shifting to a target referenced to spreads --  as global yields move higher -- rather than fixed levels, may be a policy consideration.”

The BOJ’s commitment to hold yields down at around zero percent is already facing increased scrutiny, with market participants urging the central bank to allow greater volatility during meetings last month. The BOJ was seen as conducting stealth tapering when Governor Haruhiko Kuroda acknowledged in May that the rate of bond purchases is well below the annual guideline of 80 trillion yen ($701 billion).

While Kuroda has insisted that Japan still requires stimulus to reach its inflation targets, there are signs that the economic recovery is picking up pace. There is improving confidence among manufacturers, rising salaries, and higher capacity usage. At a quarterly meeting of the central bank’s branch managers on Monday, he said the economy is turning toward a moderate expansion, and the central bank will adjust policy as needed.

The market may test the BOJ’s commitment again on Tuesday. Speculation of a possible BOJ debt-buying operation intensified after the yield on the five-year yield rose to minus 0.035 percent Monday, the highest since January 2016, and above the minus 0.04 percent mark where the BOJ held a fixed-rate operation in November.

“The Bank of Japan’s battleground for capping yields could be shifting to two- and five-year bonds,” said Satoshi Shimamura, head of rates and markets for the investment strategy department at MassMutual Life Insurance Co. in Tokyo. The central bank could increase the amount of JGB purchases and conduct a fixed-rate operation on Tuesday, as it did on Friday to cap 10-year yields, he said.

Exit Plans

Growth may surprise on the upside and the BOJ may have to consider discussing exit plans before the end of the year, according to Principal Global Investors, which manages more than $424 billion.

“The market has re-confirmed the BOJ’s strong commitment after Friday’s fixed-rate operation,” Katsutoshi Inadome, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities, wrote in a note. While the “message was clear,” there remains concerns about the super-long sector as the central bank refrained from increasing purchases for debt in the 10-to-25-year maturity zone at Friday’s operations, he said.

While no bids were tendered into BOJ’s offer to buy an unlimited amount of 10-year notes at 0.11 percent Friday, the announcement itself sent the yield down to close at 0.085 percent. The yield climbed to 0.09 percent Monday while the yen weakened for a second day.

Friday’s operation was a line in the sand, according to Naoya Oshikubo, a rates strategist at Barclays Securities Japan Ltd. “Market consensus has been set that 0.11 percent for the 10-year government bond yield will be the top in BOJ’s current yield-curve control scheme,” he said.

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