Bank of Japan Yields to Market Pressure

Investors are usually advised to go along with the Federal Reserve's decisions. However, Japan has recently demonstrated that it is possible to challenge the central bank and come out victorious.

On Tuesday, the Bank of Japan (BOJ) made a significant move by raising the cap on 10-year government bond yields from 0.25% to 0.5%. This decision had a ripple effect across the globe, as yields that had been held down by the BOJ suddenly jumped, causing yields on Treasurys and bonds in other developed markets to rise. The yen experienced a surge of more than 3%, briefly having its biggest gain since 2009 before retreating slightly, while Japanese stocks experienced a dip.

Two noteworthy aspects are evident. Firstly, the Bank of Japan has started to move away from its "yield-curve control" policy, which had become increasingly unrealistic, without causing any major disruption to the markets thus far.

I'm relieved to hear this news. I was worried that a sudden change in policy by the Bank of Japan would have a negative effect on those who had placed their bets on the BOJ staying the course, potentially leading to market instability. The Swiss National Bank's SNBN -0.20% decision to abandon its currency peg is a prime example of this.

In 2015, Switzerland made a drastic change by abandoning its currency-control policy, which had a huge impact on several hedge funds. This occurred during a period when the markets were generally tranquil.

Moreover, the Bank of Japan has yet to reach its goal of restoring its domestic markets to their usual state.

Mark Dowding, chief investment officer of BlueBay Asset Management, believes that the yield curve control ceiling will be raised again. He is betting on increasing yields and believes that the ceiling could reach 0.75% by the end of March, or even be removed altogether. He stated, “The genie’s out of the bottle and they’ve moved the yield curve control ceiling once so we think they will move it again.”

The Bank of Japan's yield curve control did not have the desired effect of controlling the yield curve, which is typically visualized as bond yields arranged from short to long maturity. Instead, the BOJ capped the 10-year yield at 0.25%. With inflation increasing at its highest rate since 1982, investors who were expecting higher rates drove the nine-year and 11-year yields far above the 10-year, creating a kink in the curve that demonstrated their lack of confidence in the Bank of Japan's 8301 4.13%.

Rules and regulations are an important part of any organization or institution. Having a set of policies in place helps to ensure that everyone is on the same page and that everyone is following the same guidelines. This helps to create a sense of order and structure, which is essential for any successful organization.

On Tuesday, the upper limit permitted 10-year yields to increase, although not as much as expected to 0.5%. Unfortunately, the Bank of Japan's (BOJ) concern about the kink in the curve was not alleviated, as the eight- and nine-year yields remain higher than the 10-year. In a healthy market, this kink should be eliminated, however, the BOJ's attempts to keep 10-year yields low make this impossible.

The Bank of Japan (BOJ) has removed the cap on the 10-year government bond yield, claiming that the move was made to stabilize the market and not to tighten monetary policy against inflation. However, the reason why there is a problem in the market is because investors believe that the increasing inflation will cause the BOJ to raise interest rates. The next inflation report is due on Thursday and is predicted to show a further increase, with consumer prices excluding fresh food already at a 40-year high of 3.5%, which is higher than the BOJ's desired rate of 2%.

The Bank of Japan has the authority to determine the 10-year yield and any other yield. However, they face the same issue the Federal Reserve encountered in the 1940s when they had control of the yield curve. If investors do not think the yield is sufficient, the only way to maintain control is for the central bank to continue purchasing bonds.

The Bank of Japan has declared that it is ready to increase its bond purchases from 7.3 trillion yen (equivalent to $55.1 billion) to 9 trillion yen per month.

In 1951, the Federal Reserve relinquished its authority over bond yields. The Bank of Japan is still holding on, but as long as inflation remains a concern, the markets will continue to challenge them. Ultimately, the BOJ will have to either purchase all the bonds or surrender the struggle.