Japan’s yield curve control is “broken” — DB

All monetary eyes are on Japan at the moment, where the central bank’s resolute commitment to mega-loose policy sticks out like a sore thumb. Deutsche Bank argues its yield curve control is now de facto dead.

While most other central banks around the world have gotten their hike on in 2022, the Bank of Japan has stuck to its strategy of holding short term rates below zero and pinning the yield of the 10-year Japanese government bond market at or below 0.25 per cent.

The motivation is to finally break free of the deflationary miasma that has plagued Japan for a few decades now. But it has pretty much killed trading in JGBs, and led to the yen crapping the bed this year.

DB’s George Saravelos, global co-head of FC research at the German bank, argues that YCC is now “for all intents and purposes, already broken”:

Only the three 10-year government bond yields that are now eligible for the BoJ’s fixed rate buying operations trade at or below the 25 basis point yield cap. Bonds maturing on either side of the targeted maturity now trade with yields materially higher than the cap.

To be sure, if it wasn’t for the Bank of Japan’s unlimited fixed rate tenders and broader QE, the entire Japanese yield curve would likely be significantly higher. But the “broken” curve not only demonstrates the scale of policy distortion but its likely limits too: with the Bank of Japan reaching near-full ownership of those three specific bonds, the time is soon approaching where these bonds will stop trading in their entirety and the market will simply cease to exist. There will be no willing seller of ten-year bonds at the Bank of Japan’s designated purchase “price”.

We have been arguing for some months that FX intervention from the Japanese authorities will not work when the move higher in USDJPY is driven by Bank of Japan policy itself. It is either the BoJ or the broad USD anti-risk parity dynamics that need to shift to change USD/JPY direction. So long as neither is materialising, FX intervention looks pretty futile — especially if it ultimately leads to foreign exchange reserve sales which ultimately push global yields even higher.

Here’s the chart Saravelos has produced to hammer home his point.

We agree that as long as Japanese monetary policy is set where it is, Japan’s fitful attempts to jawbone/directly intervene to support the yen is likely going to be in vain.

The suggestion that significant foreign reserve liquidation by countries like Japan to support their currencies is actually making things worse — by lifting US Treasury yields and thereby giving the US dollar a further boost — is also intriguing.

But FTAV Towers is a little bit worried about what might happen if the BoJ really does buckle. Right now its commitment to keeping interest rates and bond yields low is the biggest anchor of the entire global fixed income complex, which is already fraying in some places.

What happens if the BoJ turns?