Global markets were jolted overnight after the Bank of Japan unexpectedly widened its target range for 10-year Japanese government bond yields, sparking a sell-off in bonds and stocks around the world.
The central bank caught markets off guard by tweaking its yield curve control (YCC) policy to allow the yield on the 10-year
Japanese government bond (JGB) to move 50 basis points either side of its 0% target, up from 25 basis points previously, in a move aimed at cushioning the effects of protracted monetary stimulus measures.
In a policy statement, the BOJ said the move was intended to “improve market functioning and encourage a smoother formation of the entire yield curve, while maintaining accommodative financial conditions.“
The central bank introduced its yield curve control mechanism in September 2016, with the intention of lifting inflation toward its 2% target after a prolonged period of economic stagnation and ultralow inflation.
The BOJ — an outlier compared with most major central banks — also left its benchmark interest rate unchanged at -0.1% on Tuesday and vowed to significantly increase the rate of its 10-year government bond purchases, retaining its ultra-loose monetary policy stance. In contrast, other central banks around the world are continuing to hike rates and tighten monetary policy aggressively in an effort to rein in sky-high inflation.
The YCC change prompted the yen and bond yields around the world to rise, while stocks in Asia-Pacific tanked. Japan’s Nikkei 225 closed down 2.5% on Tuesday afternoon. The 10-year JGB yield briefly climbed to more than 0.43%, its highest level since 2015.
By midafternoon in Europe, the U.S. dollar was down 3.3% against the surging yen. The yen’s rally saw the currency notch the biggest single-day gain against the U.S. dollar since March 1995 (27 years, eight months, 20 days), according to FactSet currency data.
U.S. Treasury yields spiked, with the 10-year note climbing by around 7 basis points to just below 3.66% and the 30-year bond rising by more than 8 basis points to 3.7078%. Yields move inversely to prices.
Shares in Europe retreated initially, with the pan-European Stoxx 600 shedding 1% in early trade before recovering most of its losses by late morning. European government bonds also sold off, with Germany’s 10-year bund yield up almost 7 basis points to trade at 2.2640%, having slipped from its earlier highs.
‘Testing the water’
“The decision is being read as a sign of testing the water, for a potential withdrawal of the stimulus which has been pumped into the economy to try and prod demand and wake up prices,” said Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.
“But the Bank is still staying firmly plugged into its bond purchase program, claiming this is just fine tuning, not the start of a reversal of policy.”
That sentiment was echoed by Mizuho Bank, which said in an email Tuesday that the market moves reflect a sudden flurry of bets on a hawkish policy pivot from the BOJ, but argued that the “popular bet does not mean that is the policy reality, or the intended policy perception.”
“Fact is, there is nothing in the fundamental nature of the move or the accompanying communique that challenges our fundamental view that the BoJ will calibrate policy to relieve JPY pressures, but not turn overtly hawkish,” said Vishnu Varathan, head of economics and strategy for the Asia and Oceania Treasury Department at Mizuho.
“For one, there was every effort made to emphasize that policy accommodation is being maintained, whether this was in reference to intended as well as potential step-up in bond purchases or suggesting no further YCC target band expansion (for now).”
Spikes in volatility
The Bank of Japan noted in its statement that since early spring, market volatility around the world had risen, “and this has significantly affected these markets in Japan.”
“The functioning of bond markets has deteriorated, particularly in terms of relative relationships among interest rates of bonds with different maturities and arbitrage relationships between spot and futures markets,” it added.
The central bank said if these market conditions persisted, it could have a “negative impact on financial conditions such as issuance conditions for corporate bonds.”
Luis Costa, head of CEEMEA strategy at Citi, indicated on Tuesday that the market move may be an overreaction, telling CNBC there was “absolutely nothing stunning” about the BOJ’s decision.
“You have to take this BOJ measure in the context of a positioning in dollar-yen that was obviously not expecting this tweak. It’s a tweak,” he said.
Japanese inflation is projected to come in at 3.7% annually in November, according to a Reuters poll last week — a 40-year high, but still well below the levels seen in comparable Western economies.
Costa said the Bank of Japan’s move was not geared toward combating inflation but addressing the “infrastructure and the dynamics of JGB trading” and the gap in volatility between the trade in JGBs and the rest of the market.
