Successive increases in 10-year JGB yields fuel ongoing speculation about further YCC tweaks

On October 24, we saw 10-year JGB yields—the benchmark in the Bank of Japan’s Yield Curve Control (YCC) framework—rise temporarily to 0.88%, hitting a new record level surpassing the previous high from 2013.

In response, the Bank of Japan carried out emergency JGB purchase operations. The bank purchased 300-billion-yen worth of bonds with five to ten years left until maturity, and another 100-billion-yen worth of bonds with ten to twenty-five years left until maturity, making for a total of 400 billion yen in bond purchases. This emergency operation was the third such move the bank has made in October, following those made on the 4th and the 18th. The volume of bonds purchased was also the same as that of the previous time on the 18th.

Furthermore, that same day the Bank of Japan gave notice regarding funds-supplying operations against pooled collateral with a duration of five years. The amount in that notice was one trillion yen, the same as it had been the previous time. The Bank of Japan’s stance has thus become bolder, in an effort to stem further increases in yields.

With 10-year JGB yields successively hitting new record highs, speculation is simmering that the Bank of Japan might decide to make additional tweaks to YCC following those made in July at its next Monetary Policy Meeting, which is scheduled to be held on October 30 and 31.

Facing a dilemma between maintaining the YCC framework and preventing the yen’s depreciation

If 10-year JGB yields were to rise to the level of 1.0%, their de-facto upper limit, then the Bank of Japan would be forced to dramatically increase its JGB purchases, just as it did last year. That would produce harmful effects, such as causing the Bank of Japan’s balance sheet to balloon, exacerbating the distortions in the JGB market, and deepening the current tendency toward government financing.

Back in July when the BOJ went through with its first tweaks to YCC, Governor Ueda made it clear that the resulting drop in exchange rate volatility was intentional. Preventing the yen from depreciating was also the bank’s aim. By making this tweak to YCC, the Bank of Japan created more room for 10-year JGB yields to increase. Allowing such increases made it possible to curb the pace of growth in the gap in long-term bond yields between Japan and the U.S., enabling the framework to effectively halt the depreciation of the yen. However, there is now little room left for 10-year JGB yields to increase.

In order to maintain its YCC framework, the Bank of Japan does have the option of purchasing additional JGBs through emergency purchase operations, so as to better prevent 10-year JGB yields from rising further, but if it does that, then beyond the harm caused with those bond purchases, there would also be the problem of the progressive depreciation of the yen.

The government presumably considers the exchange rate of 1USD/150JPY to be its defensive line, and if the BOJ’s operations trigger the yen to exceed this rate, that could cause the bank’s cooperation with the government on stabilizing exchange rates to fall apart. It could also lead people to believe these actions have brought about a terrible depreciation of the yen that will intensify inflationary pressures, thus exposing the Bank of Japan to a flood of criticism as happened last year.

The Bank of Japan finds itself confronting a dilemma between two objectives, namely maintaining its YCC framework and preventing the yen’s depreciation, and it is becoming increasingly trapped.

If we consider things in these terms, we can’t fully deny the possibility that before the situation gets even worse, the Bank of Japan could decide at its next Monetary Policy Meeting to raise its de-facto YCC cap of 1.0%, or alternatively, to abolish its variability range or make other such further tweaks.

Rise in long-term JGB yields also driven by speculations over further YCC tweaks

However, 10-year U.S. Treasury yields have recently fallen somewhat after having risen to 5%. Up to now, when long-term JGB yields in Japan have risen they have been pulled along by rising long-term Treasury yields in the U.S., but lately those long-term Treasury yields have ceased to rise, while long-term JGB yields have still been rising in Japan. Speculations that the Bank of Japan will choose to make further tweaks to YCC at its next Monetary Policy Meeting are likely playing a major role in this rise.

The Bank of Japan’s YCC management policy is to tolerate fluctuations in long-term JGB yields which are supported by the fundamentals (like changes in the inflation expectations), while also curbing fluctuations attributable to speculative factors. Any increase in long-term JGB yields based on expectations over further YCC tweaks by the Bank of Japan arguably would involve speculative factors. Furthermore, after the Monetary Policy Meeting on October 30 and 31 has passed, such speculation will calm down.

Is now the time to keep pushing forward?

The sustainability of the rise in long-term U.S. Treasury yields—which has driven long-term JGB yields in Japan to rise—is also uncertain. The fact that 10-year U.S. Treasury yields are around 5% seems somewhat incongruous as well, in light of economic fundamentals.

The rise in long-term Treasury yields since the summer has been having adverse effects on the U.S. housing market, and if those effects were to spread to consumer spending, they could lead the U.S. economy into a much more apparent slowdown, which could drive down long-term Treasury yields, and could also prompt the U.S. dollar to lose value against the yen in the exchange market.
And in the short term, it’s even conceivable that it won’t be the BOJ’s operations, but instead will be changes in the U.S. economy or monetary policy stance that trigger the exchange rate to exceed 1USD/150JPY and cause the yen to depreciate, leading the government to embark on a full-scale foreign exchange intervention.

If that happens, the Bank of Japan might no longer need to remain so cautious about preventing long-term JGB yields from rising, fearing that it had set the stage for the yen to depreciate past the level of 150 yen to the dollar, and that it would therefore face criticism from the government or the people. 

With a little more patience, the Bank of Japan might find that its current predicament of being caught between maintaining the YCC framework and preventing the yen’s depreciation can be overcome.

The likelihood that another tweak could be delayed seems marginally higher, but…

To say the least, the Bank of Japan would probably like to avoid having to follow its first YCC tweak with another one just two months later, even simply from the standpoint of maintaining credibility.

Given these many points at issue, one might say that it’s rather tricky to guess whether the Bank of Japan will go through with another YCC tweak at its next Monetary Policy Meeting on October 30 and 31.

At present, I would prefer to suppose that the BOJ is slightly more likely to put off another such tweak, but depending on how the situation unfolds over the next week, the possibility could very well swing heavily either way.

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  Takahide Kiuchi

  Executive Economist