The Economist
Thu, November 2, 2023
The bank of japan (boj) failed to deliver a Halloween thriller. Even as central banks elsewhere have raised interest rates in recent years, the boj has stuck with its ultra-loose policy, designed to stimulate growth. Japan’s benchmark interest rate sits at -0.1%, where it has been for seven years. And on October 31st, despite building pressure, the bank decided merely to tweak its cap on ten-year government-bond yields. The 1% ceiling on yields, which the bank makes enormous bond purchases in order to defend, is now a reference rather than a rule. Indeed, yields on the benchmark bond are at 0.95%, their highest for over a decade (see chart).
After the boj’s announcement, the yen fell to ¥151 to the dollar, its lowest in decades. Inflation, long quiescent, is no longer so low—the boj raised its forecasts for underlying “core” inflation over the next three years. Many analysts expect the central bank to end its yield-curve-control policy once and for all early next year, and to have raised interest rates by April. But even when the boj does finally raise interest rates, it is likely to be by just a fraction of a percentage point, meaning the gulf between Japanese bond yields and those in the rest of the world will remain large, with major consequences for global financial markets. A fright is still in the offing.
To understand why, consider the impact Japan’s rock-bottom interest rates and continued intervention to suppress bond yields have had. Low rates at home have generated demand for foreign assets, as investors seek better returns. Last year the income from Japan’s overseas investments ran to $269bn more than was made by overseas investors in Japan, the world’s largest surplus, equivalent to 6% of Japanese gdp. The huge gap between bond yields in Japan and those in the rest of the world now presents dangers to both the Japanese investors that have bought foreign bonds and the global issuers that have benefited from Japanese custom.
Jeopardy is particularly apparent at Japan’s largest financial firms, which make big investments abroad. The cost of hedging overseas investments depends on the difference between the short-term interest rates of the two currencies at play. America’s short-term interest rates are more than five percentage points above Japan’s equivalent, and the gap exceeds the 4.8% yield on ten-year American government bonds. This means Japanese buyers now make a guaranteed loss when buying long-term bonds in dollars and hedging their exposure. Hence why the country’s life insurers, which are among the institutions keenest to hedge their currency risk, dumped ¥11.4trn ($87bn) in foreign bonds last year.
The huge gap between short-term interest rates means that Japanese investors now have more limited options. One is to continue buying overseas, but at greater risk. Meiji Yasuda Life Insurance and Sumitomo Life, each of which held more than ¥40trn in assets last year, say they will increase their overseas bond purchases without hedging against sudden currency shifts, in effect betting against a sudden rise in the yen. Life-insurance firms are usually conservative, but the longer the enormous gap in interest rates persists, the more they will be encouraged to take risks.
Meanwhile, rising yields on long-term Japanese bonds, which will surely rise further still if the boj does abandon yield-curve control, may tempt local investors to bring home their money. Japan’s 40-year bonds offer yields of 2.1%—enough to preserve the capital of investors even if the boj hits its target of 2% inflation. Martin Whetton of Westpac, a bank, says that this prospect ought to worry firms and governments in America and Europe used to a voracious Japanese appetite for their bonds.
In such a scenario, a source of demand would turn into a source of pressure on the funding of Western firms and governments. The yen might then surge, as Japanese investors sell foreign-currency debt and make new investments at home. Bob Michele of JPMorgan Asset Management warns of a decade of capital repatriation.
The flow of Japanese capital to the rest of the world, which emerged during a decade of easy monetary policy around the world, looks likely to be diminished. Whether the resulting pain will be felt by local financial institutions, or foreign bond issuers, or both, will become clearer over the months to come. What is already clear is that it will be felt by someone.
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Japan Faces Speculators on Two Sides Challenging the Yen, Bonds
Ken McCallum
Wed, November 1, 2023
(Bloomberg) -- The contradictions in Japan’s efforts to protect the yen while slowing the pace of rising bond yields are becoming increasingly clear in currency and debt markets.
While Thursday presents a slightly different picture after the Federal Reserve kept rates on hold, the action in Tokyo on Wednesday underscores Japan’s huge challenge.
The day began with the nation’s top currency official at the finance ministry giving one of the starkest warnings yet that authorities were ready to intervene in the foreign exchange market to stem the yen’s fall. By lunchtime the Bank of Japan was preparing to wade into the debt market to slow the speed of the 10-year bond yield’s ascent toward 1%.
The BOJ’s unscheduled bond purchases were jarring — coming just 24 hours after the central bank removed its 1% cap on these yields. The operation also worked directly against efforts to support the yen, which is being weighed down by the wide gulf between interest rates in Japan and the US.
The upshot for the currency was a 0.5% advance Wednesday and a further 0.2% gain so far Thursday. That’s taken it away from the 151 level versus the dollar, but it remains well within sight if its 33-year low set last year. The 10-year bond yield still ended up for the day and was just 1.5 basis points below the fresh decade high it set before the central bank announced its buying operations. Bond futures point to lower yields Thursday while the longer-term picture for gains is unchanged, and a 10-year debt auction due later in the day has traders on edge.
“The MOF and BOJ’s actions are out of sync,” said Tsuyoshi Ueno, senior economist at NLI Research Institute, who sees the answer to the problem lying out of their hands and in any future interest rate cuts in the US. “Until then, authorities will have to be patient.”
Speculators in both markets are betting that Japan’s policymakers won’t be able to maintain their balancing act, and the stakes are rising. An excessive yen depreciation could worsen Japan’s inflation, in part by pushing up import prices, while higher yields could prematurely crimp Japan’s recovery.
“We’re on standby,” said Masato Kanda, the top currency official at the ministry, echoing language he used a year ago on the day Japan made the first of three forays into the market. “But I can’t say what we’ll do, and when — we’ll make judgments overall, and we’re making judgments in a state of urgency.”
Read more: Japan Ramps Up Yen Intervention Warning After BOJ-Fueled Selloff
His comments on Wednesday followed the yen’s biggest one-day drop since April on Tuesday after the BOJ’s underwhelming tweak to its cap on bond yields showed that moves away from ultra-loose policy would likely continue to be slow and gradual.
Japan’s stock market, on the other hand, the Topix index climbed the most in more than a year because of the tailwind to equities from low borrowing costs and the weak yen.
While Japan’s 10-year benchmark yield had doubled since July 27, one day before Governor Kazuo Ueda made his first tweak to yield-curve control, it is still about four percentage points below its US equivalent.
The BOJ appears intent on moderating moves while traders are constantly trying to push yields higher.
“Although the BOJ took action to discourage rises in yields, market players probably want to see the long-term yield reaching 1%,” said Keisuke Tsuruta, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities Co.
He added that the unscheduled buying operation this time may have been a pre-preemptive move before the closely-watched 10-year bond auction Thursday.
BOJ Buys More Bonds to Slow Rising Yields a Day After Tweak
“At the bottom of the BOJ’s thinking is its lack of assurance that they could achieve sustainable inflation of 2%, so a somewhat easy monetary policy needs to be maintained,” said Shusuke Yamada, head of Japan currency and rates strategy at BofA Securities Inc. “For the finance ministry, it’s looking at volatility and trading levels for foreign exchange. Letting the yen weaken has disadvantages for consumers.”
--With assistance from Yumi Teso and Daisuke Sakai.
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