Slowly but surely, Japan’s bond market is approaching its inevitable disintegration.
With the BOJ caught in an impossible dilemma, where on one hand it is facing soaring inflation and is forced to tighten monetary policy to prop up and push the imploding yen higher in order to avoid social rebellion, while on the other hand, said tightening is pushing bond yields ever higher as the BOJ steps away from being the buyer of first, last and any other resort, a bond market which is majority owned by the same BOJ, this morning Japan’s 10-year government bond yield climbed to 1% for the first time in 11 years, propelled by growing expectations that the BOJ will have to take further tightening steps in the coming months as rampant inflation persists .
The 10-year yield briefly touched the threshold Wednesday, its highest level since May 2013, before swinging both below and above the historic level later in the session.
Longer-term JGB yields climbed more sharply than the 10-year yield. The 30-year yield was recently 5.5 basis points higher at 2.140%.
Investors have been speculating about the timing of another Bank of Japan rate hike and a possible reduction in its government-bond purchases after the BOJ ended its negative interest-rate policy and halted much of its unorthodox easing measures in March, which however were viewed as so dovish and were so eagerly telegraphed, the decision to “tighten” actually sent the yen plummeting, and unleashed even more inflation.
Some analysts say the Japanese central bank might slow its bond-buying partly to support the yen, which has depreciated sharply over the past couple of years as the BOJ maintained its ultraloose monetary policy while other central banks raised interest rates.
Last week, the BOJ offered to buy a smaller amount of Japanese government bonds maturing in five to 10 years on the following day compared with its previous operation, and maintained the reduced amount on Friday. That raised speculation that it will start winding back its monthly JGB purchases.
Commenting on the yen’s muted reaction to the 10Y JGB yield hitting 1%, BofA strategist Shusuke Yamada said the key point is that market volatility has decreased, making it easier to sell the yen for low-interest-rate carry trades. Indeed, the USDJPY rose to a session high of 156.60 briefly in Tokyo as outward direct investment and outward securities investment through NISA continue to be in the background. As for yen interest rates, nominal rates are rising, but real rates are still negative.
Meanwhile, the strategist also noted that Japan-US interest rate differential is still above 5% for the short term, which is the target of the carry, and yen is not going to strengthen just because the interest rate differential has narrowed a little. In fact, according to Yamada, the valuation of the yen as undervalued will not come into play until the short-term Japan-US interest rate differential falls below at least the 3% level. For example, even if interest rate differentials in the 5% range stop falling at the 4% level, it is difficult to correct the yen’s depreciation
