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The Bank of Japan (BOJ) is taking steps to relinquish its near monopoly on control over Japan’s bond market, signaling a shift in the balance of power toward investors. Since its introduction of yield-curve control (YCC) in September 2016, the BOJ has meticulously overseen the government debt market, accumulating ownership of more than 50% of outstanding bonds. However, with the central bank now indicating its readiness to allow the benchmark 10-year yield to exceed 1%, investors appear poised to regain a more prominent role.
The recent adjustment to the effective ceiling for the 10-year yield, marking the third change since December, underscores the challenges the BOJ faces in sustaining YCC. Reduced clarity in the BOJ’s guidance is expected to exert upward pressure on yields, aligning with Japan’s near four-decade high inflation and the hawkish policy stances adopted by other major central banks.
Tom Nash, a portfolio manager at UBS Asset Management, highlighted this shift, stating, “We can see the bigger picture that YCC is being dismantled, and that the market is back. Now, 1% is no longer a hard limit requiring unlimited firepower but a reference point, so Japanese Government Bonds (JGBs) will test that level in the coming weeks.”
Signs of the BOJ moving away from yield-curve control are evident in its decision to discontinue daily unlimited bond-purchase operations and to withhold yield levels at which the central bank conducts purchases. Initially an ad-hoc procedure, these operations became daily activities last year.
Sayuri Shirai, a professor of economics at Keio University in Tokyo and a former BOJ monetary policy board member, described Tuesday’s decision as “a very strong signal,” emphasizing that the BOJ is no longer willing to purchase an unlimited amount of bonds.
Ten-year overnight-indexed swaps, utilized by investors for betting on or hedging against higher bond yields, now trade 15 basis points above the BOJ’s 1% reference point.
Furthermore, the BOJ has revised its inflation projections, anticipating a key price gauge to remain well above its 2% target for three consecutive years, a phenomenon not witnessed in Japan since 1992. While the central bank still wields significant influence through bond purchases and an unconventional negative-rate policy, the possibility of prolonged inflation is likely to fuel speculation about the BOJ’s policy normalization.
Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank Ltd. in Tokyo, noted, “The market is getting back at least half of its power to determine bond yields.”
