Receive free Bank of Japan updates
We’ll send you a myFT Daily Digest email rounding up the latest Bank of Japan news every morning.
Aside from Norway finally getting its act together to smash a way through to the next round of the World Cup, last week’s big event was obviously the Bank of Japan deciding to fiddle around with its yield curve control again.
Widening the 10-year Japanese government bond trading band from 0.5 per cent to 1 per cent was an “opaque” “giant leap” and a “de facto abolishment of yield curve control”, according to various analysts quoted by our mainFT colleagues.
Here’s the BoJ’s own explanation:
Given the BoJ’s role as a kind of global monetary anchor and the importance of Japanese investors to global markets — some say Japan is the Saudi Arabia of savings — a lot of people are naturally worried about the ripple effects.
Here’s a slide deck that Apollo’s chief economist Torsten Sløk sent out to clients over the weekend. His main point is:
With yields going up in Japan, the risk is that Japanese investors will now begin to sell US fixed income and start buying higher-yielding Japanese fixed income.
This is a big deal for global fixed income markets because Japanese investors are the biggest foreign holder of US Treasuries, and they also own significant amounts of US credit.
This is not just a potential US bond market issue though. Japanese institutional investors overall hold about $2tn worth of foreign bonds, much of which is also in German, French or UK debt.
And as Brad Setser and Alex Etra detailed earlier this year, they have already flipped from buying about $100bn of international bonds a year over the past decade to selling almost $200bn last year. Anything that accelerates that could become quite disruptive. As one hilariously shrill analyst put it to Reuters, the BoJ is “on the tightest of tightropes above the pit of alligators”.
However, will higher Japanese government bond yields and the expensiveness of currency hedging really lead to a mass exodus from overseas markets? It seems unlikely, given that Japanese investors have ample liquidity, and the vast majority is apparently held in hold-to-maturity portfolios. Selling now would therefore probably crystallise some chunky losses.
Rabobank highlights the steadiness of Japanese swap spreads as evidence that local investors aren’t exactly girding themselves for a “great repatriation”. Here are their overnight thoughts, with Alphaville’s emphasis below.
The basic line of thought here appearing to be that:
— The change from the BoJ will herald higher JGB yields.
— Higher JGB yields will encourage Japanese insurers/ pension funds to run down their FX-hedged overseas bond holdings (specifically EGBs). This is because the latter will offer a diminishing yield pick-up over JGBs.While this argument appears to be intuitively appealing given the large volume of overseas bonds held by Japanese investors, we have a few issues with it:
— The yield-pick up of EGBs over JGBs has already not been attractive for a period of months.
— The argument assumes that the only interest of Japanese investors in overseas bonds is FX-hedged yield pick-up. However, we would assume that the prospect of higher JGB yields and a close to peak ECB policy rate would encourage some holders of JGBs to switch into EGBs for capital pick-up. In summary, we think that there is often an overly simplistic view of the motivation of Japanese investors. Interestingly the 10yr Japanese swap spread moved by frighteningly little on the day which doesn’t suggest that JGB holders themselves are anticipating a massive repatriation into domestic govvies.
— German swap spreads appeared to be under narrowing pressure from the prospect of Japanese investor bond sales. However, it is widely understood that the largest EGB holdings for Japan are in French bonds. France’s bonds did not underperform versus Germany in comparison to its EZ peers. This places some doubt on the substance of the narrowing move in swap spreads.
— Japanese investors are likely to be using rolling 3-month FX-forwards for the hedging of their EGBs holdings. However, the EURJPY cross-currency basis market should also give some form of indication of the keenness of investors to sell their EUR and buy JPY. The 5yr EURJPY basis did indeed move higher on the day by c. 3bp but this still sits in the middle of a range that has held since December 2022.
The BoJ also seems determined to make sure that the widening of the 10-year JGB trading band doesn’t get interpreted as it stepping back entirely. This morning it conducted an unscheduled purchase of ¥300bn ($2.1bn) in five- to 10-year JGBs, which pushed yields back down again.
So for now, this seems unlikely to cause any major issues? Wake us up when/if the BoJ scraps YCC entirely.
Read the full article here