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December 20, 2022 at 12:25 PM
What You Need to Know
- Markets don't like uncertainty, and even a suggestion that Japan might let bond yields go higher is enough to rattle some investors.
- Most importantly, the move adds weight to the recent downturn in the strength of the U.S. dollar.
- The BOJ had been struggling to boost inflation by maintaining super-easy monetary policy without having the yen suffer disproportionately.
The year isn’t yet done with rattling investors’ cages. The Bank of Japan’s surprise widening of its yield curve-control policy on 10-year government bonds will have an impact far beyond its shores.
The decision may be ostensibly designed to improve the functioning of its domestic government and corporate bond markets — which have sunk into an illiquid quagmire — but the unspecified reasons may be more compelling.
Most importantly, the move adds weight to the recent downturn in the strength of the U.S. dollar. The BOJ had been struggling to square a circle: To boost inflation by maintaining super-easy monetary policy without having the yen suffer disproportionately.
According to Kit Juckes, currency strategist at Societe General SA, the yen is at its lowest real effective rate since 1973. In October — when the yen briefly topped 150 to the dollar — Japan had some tactical success turning the tide when it deployed foreign exchange reserves.
Now there is some definitive policy strategy to back it up. That matters because the BOJ can’t just sell off reserves forever. The yen gained nearly 4% to the dollar.
If the dollar weakens further, it will make life easier for the rest of the world, too. The euro’s breach of parity with the greenback this autumn, and sterling’s worryingly close dalliance, now look to be more confidently in the rearview mirror. Developing markets will also be relieved.
Global equity and bond markets, however, will see seasonal hopes for a rally dissipate.
Japan stocks were hit hard, and the country’s 10-year government bond yields rose 10 basis points to 0.4%. There was one bright spot though: The banking sector leapt for joy at the prospect of a steeper yield curve allowing their net interest margins to widen.
The knock-on effects were seen immediately with the U.S. Treasury curve steepening as long-end bond yields rose more. At the same time, euro and U.K. bonds saw absolutely no respite in their significant shift higher in yield since the European Central Bank’s hawkish message last week.
A strengthening yen may prompt more repatriation from Japanese investors, a persistent trend this year.
The BOJ has been the last holdout on negative rates, so these tentative signs that it might be buckling will heighten expectations we may be in for more unsettling volatility in 2023.
