For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Japan has spent around three decades in a deflationary environment. Since 2016, the Bank of Japan (BoJ) has engaged in yield curve control (YCC), with short rates set at -0.1% and, for the 10 year Japanese government bond (JGB), a 0% target, albeit within a band. As of today, it is the only central bank with negative rates.
In December last year, with domestic inflation consistently above target, and with the BoJ increasingly isolated from other central banks pushing rates higher, the BoJ widened the band to 0.5% above or below zero. Then, at the BoJ’s meeting towards the end of July this year, they announced the yield band would be a “reference”, rather than a “rigid limit”, and they also signaled that they would allow the 10 year yield to rise up to 1%.
Not the most straight forward of policy changes and one which the BoJ has been keen to frame as a tweak, rather than the end of YCC, or even a pivot. The degree of message complexity is partly explained by the fact that the BoJ is walking a fine line: they want more optionality but not to the degree that they introduce too much uncertainty to markets.
At this stage it’s difficult to be definitive about what this is a step towards, in part as the next steps depend on how the market perceives the policy change and the degree to which underlying inflation remains elevated and, specifically, the degree to which wages growth firms.
That said, we can make some initial observations about what this policy change is. Without stating the obvious, it still is YCC, but with more flexibility and so allows rates to rise more freely, in line with inflation. It is also, to some degree, policy tightening, even if short rates remain negative. More significant moves would be rates moving into positive territory and the winding down of QE.
What about the implications of the move? Again, it depends on what it is a step towards but at this stage we can make some early observations around the implications of the policy change.
On the back of the news, the JGB 10 year yield moved to a nine year high, albeit to only 0.6%. It should come as no surprise that, with a wider band, more volatility was likely and, indeed, that it would be upside yield volatility.
We don’t have any JGB exposure in our portfolios, though we do have some exposure to a basket of Japanese equity. Nevertheless, the bigger question is what does it mean, if anything, for global yields, global liquidity flows and global asset allocation?
To the degree that JGB yields have acted as an anchor for global yields, this policy change will see higher JGB yields act as a loosening of that dynamic. In practice, if we see higher JGB yields and a subsequent stronger yen, this will likely lead to Japanese investors repatriating some of their material overseas assets, simply on a relative attractiveness basis.
In a similar vein, there is also the carry trade to consider, where investors borrow cheaply in yen to invest in other assets, such as higher yielding currencies for example. However, higher JGB rates, and a stronger yen, will make many investors reassess this trade.
In summary, yields are grinding higher but yield curve control is still very much in play for now, evidenced by some material unscheduled purchases of JGBs by the BoJ since the announcement. Either way, policy risk remains under the spotlight.