Skip to main content

Bank of Japan tweaks its yield curve control policy: market implications

The Bank of Japan’s recent decision to fine-tune its yield curve control policy may have caught investors off guard; however, the bigger surprise could be that the adjustment was less hawkish than expected.

The Bank of Japan (BoJ) surprised the market by announcing an adjustment to its yield curve control (YCC) policy on July 28. A survey of analysts earlier in the month showed that only 18% of respondents had expected a tweak to take place in July, with the majority expecting any change to materialize in October at the earliest. While surprising in its timing, the actual detail in the YCC tweak, in our view, was perhaps a little less hawkish than the market had envisaged it to be. 

What was the tweak?

The BoJ has kept its 10-year yield target at around 0% and maintained the official +/-50 basis points (bps) range. What’s changed is that the central bank will now take a more flexible approach to implementing the policy in which the +/-50bps range will serve as a reference instead of a rigid limit. The policy adjustment seems to offer some scope to widen the trading range for Japanese government bonds (JGB) to +/-100bps by implementing a 10-year JGB buying operation at a 1% yield every business day through its fixed-rate operations.

The justification for the tweak was to mitigate the negative impact on bond market functioning from its policy, and we should be careful not to overinterpret the policy adjustment as a form of monetary tightening. In fact, the BoJ noted that it’ll add to easing without hesitation and seemed to imply that additional quantitative easing remains a possibility.

Supporting that notion, the BoJ’s inflation and growth forecasts were modest, although the bank did acknowledge that the balance of risks (in relation to its projections) was skewed to the upside.

BoJ’s economic forecast, July 2023

 

2023

2024

2025

GDP

1.3 (1.4)

1.2 (1.2)

1.0 (1.0)

Core CPI

2.5 (1.8)

1.9 (2.0)

1.6 (1.6)

Source: Bank of Japan (BoJ), July 28, 2023. CPI refers to the Consumer Price Index. It tracks the average change of prices over time by urban consumers for a market basket of goods and services. It is not possible to invest directly in an index. Figures within parenthesis refer to the previous forecast. 

Market implications

Following the announcement, the Japanese yen settled lower against the U.S. dollar and 10-year JGB yields settled a little higher. Unsurprisingly, the announcement sent global government bond yields higher, taking the 10-year U.S. Treasury (UST) yield above 4%.1 Markets were concerned that a BoJ policy shift might prompt Japanese institutional investors to reduce their holdings of foreign government bonds—USTs, in particular—as the cost of hedging exchange-rate risks threaten to rise further. 

Prohibitive cost of FX hedging means bulk of flows into UST likely unhedged
Chart comparing the difference between hedged U.S. Treasury yields and unhedged U.S. Treasury yields with U.S. dollar to Japanese yen exchange rate (in reverse order). The chart shows a positive correlation between the two.
Source: Bloomberg, Manulife Investment Management, as of July 28, 2023. FX refers to foreign exchange. UST refers to U.S. Treasury. USD refers to U.S. dollar. JPY refers to Japanese yen. LHS refers to left-hand side. RHS refers to right-hand side.

That said, we think that it would take a very substantial increase in Japanese long-term interest rates (or decline in foreign long-term rates) to eliminate the interest pickup, on an unhedged basis, which Japanese investors can get on their foreign investments. In that event, we believe the most likely outcome would be an orderly foreign bond sales from Japanese investors as opposed to a wholesale liquidation of their foreign bond holdings, similar to what we saw through most of last year. If that were to happen, we believe the most vulnerable bond markets would include Australia, the Netherlands, and New Zealand since Japanese investors represent a much larger share of outstanding bonds in those markets.

Japan's foreign bond holdings as a share of the government bond market (%)
Chart showing Japan's foreign bond holdings as a share of the government bond market, as of July 26, 2023. The chart shows that Japanese investors, including the government, hold about 4.5% of the U.S. Treasuries market.
Source: Bank of Japan, Manulife Investment Management, as of July 26, 2023.

While Japanese investors are the biggest holders of USTs outside the United States, their holdings represent less than 5% of the market. Although they did unload a significant amount of USTs in 2022, history suggests that a very large share of total Japanese bond holdings will likely be held to maturity. In our view, the broad direction of USTs will still be determined by how the monetary policy in the United States, as prescribed by the U.S. Federal Reserve, will evolve in the coming months.

 

1 Bloomberg, as of July 26, 2023. 

Quantitative easing (QE) is a monetary policy in which a central bank purchases government debt or other fixed-income securities in an effort to lower interest rates, increase the money supply, and stimulate economic growth. 

Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person.

All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment, or legal advice. Clients and prospects should seek professional advice for their particular situation. Neither Manulife Investment Management, nor any of our affiliates or representatives (collectively Manulife Investment Management) is providing tax, investment, or legal advice.

This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.

Manulife Investment Management shall not assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.

This material has not been reviewed by, and is not registered with, any securities or other regulatory authority, and may, where appropriate, be distributed by Manulife Investment Management and our subsidiaries and affiliates, which includes the John Hancock Investment Management brand.

Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

3073641 

Sue Trinh

Sue Trinh, 

Former Co-Head, Global Macro Strategy, Multi-Asset Solutions

Manulife Investment Management

Read bio

Category

Tags