Japan's 10-Year Government Bond Yield Tops New Cap

The Yield on Benchmark 10-year Japanese Government Bonds Breached the 0.5% Cap set by the Bank of Japan on Thursday. This Marked the First Time that the Yield has Risen above this Level since the Central Bank Introduced Its Yield Curve Control Policy in September 2016.

The move came as a surprise to markets, as the Bank of Japan has been widely expected to maintain its current policy stance at its meeting later this month.

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As pressure grows on the central bank to tighten policy, less than a month ago, it is clear that the current monetary policy is not sustainable in the long term.
This week's strong inflation data has sparked speculation among investors that the BOJ will join the Federal Reserve and other central banks in unwinding its easing program by lifting the cap again, or even scrapping its yield-curve control policy altogether.

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On Friday, the yield on 10-year Japanese government bonds (JGBs) briefly rose to 0.545%. In response, the Bank of Japan (BOJ) bought ¥1.8 trillion ($16.8 billion) worth of JGBs with maturities from 1 to 25 years. This followed the BOJ's purchase of ¥4.6 trillion ($43.2 billion) of JGBs on Thursday, the largest daily amount of bond buying by the central bank ever.

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The yield on Japanese government bonds was 0.505% at the end of the Asian trading day. The yen rose to a seven-month high against the dollar on Friday, as slowing inflation in the United States added to market expectations that the gap in interest rates between the two countries would not widen significantly this year. The pair stood at 128.73 late in the Asian day.

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On December 20, the central bank surprised markets by letting the 10-year yield rise to 0.5%. This was above the previous ceiling of 0.25%.
Many central bank watchers believe that BOJ Gov. Haruhiko Kuroda's repeated statements that the new cap doesn't represent the start of a monetary-tightening cycle are disingenuous.

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Mitsubishi UFJ Morgan Stanley Securities strategist Naomi Muguruma said she expects the BOJ to abolish the 10-year target while keeping its minus 0.1% target for short-term interest rates in the April-June quarter after a new BOJ governor is scheduled to take over. However, she said that the BOJ could be forced to take action next week if disruptions in the market continue.

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The policy board of the bank is set to have a meeting that will last for two days and end on Wednesday.
Ms. Muguruma warned that if the BOJ attempts to keep the 10-year JGB yield from rising, investors will move into other maturity sectors of JGBs, pushing up yields and creating further distortions in the yield curve. This could make it more difficult for companies to issue bonds, as JGB yields are used as a pricing benchmark.
Ms. Muguruma noted that the market is beginning to anticipate an end to the BOJ's manipulation of the yield curve, as the central bank is getting closer to its goal of inflation in both prices and wages.

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Inflation in the Tokyo metropolitan area rose 4% in December, the fastest growth in nearly 41 years. Core inflation, which excludes fresh-food prices, also rose at a rapid pace. These data suggest that inflationary pressures are building nationwide. As annual wage negotiations approach in the spring, some companies have already announced raises. Fast Retailing Co., the owner of Uniqlo clothing stores, said this week it planned to increase annual salaries by as much as 40%.

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"We believe that our employees deserve compensation that meets or exceeds global standards for the high-quality work they provide," said chief financial officer Takeshi Okazaki at a news conference Thursday. BOJ policy makers have said that steady wage growth is the key to making current inflation a more sustainable trend. Inflation in Japan has been driven mainly by costs for higher energy and food.

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Tomohisa Fujiki, a strategist at Citi, said he expects the Bank of Japan to scrap its yield-curve control next week and announce larger purchases of Japanese government bonds to prevent yields from rising too sharply.

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According to Mr. Fujiki, once yield curve control is fully removed, short covering by speculators may push JGB yields lower as well.