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Economist Mohamed El-Erian has sounded a warning about the potential consequences of Japan’s yield curve control (YCC) exit, emphasizing the need for careful management to avoid triggering bond-market contagion and a potential “financial accident.” In an opinion piece for Bloomberg, El-Erian stressed the importance of Japan’s central bank being mindful of the impact of its YCC exit on global financial markets.
Japan’s approach to maintaining specific yield levels via YCC differs significantly from the more hawkish stance of other central banks globally, many of which have been actively raising interest rates. YCC has led to challenges such as a weakening yen and various distortions, casting doubt on central bankers’ ability to gradually phase it out.
El-Erian noted the necessity to avoid both a disorderly YCC exit and an excessively prolonged one. A disorderly exit would disrupt Japanese balance sheets, potentially forcing Japanese investors to divest their holdings of foreign corporate and sovereign bonds. Such contagion effects would compound the instability in global markets, which are already grappling with developments in the US Treasury segment. High volatility in two of the world’s most significant sovereign bond markets would increase the risk of financial accidents and pose additional headwinds to global economic growth.
To mitigate these risks, El-Erian suggested that Japan’s central bank should expedite its policy exit. Recent reports have hinted at a potential shift in policy, with government yields possibly being allowed to rise. This has already triggered a 0.8% rally in the yen against the dollar.
However, El-Erian cautioned that as external pressures on Japan persist, there is a growing likelihood that both foreign and domestic traders will challenge the central bank’s capacity to uphold its existing monetary policy. He highlighted that the larger the fissures become, the greater the risk of a forced mismanagement of the exit, resulting in negative ramifications for the US and the world, while amplifying bond-market volatility.
