Bank of Japan shocks global markets with shift in bond yields

Global markets were shaken overnight after the Bank of Japan unexpectedly extended the ceiling 1[ads1]0-year Japanese government bond yieldswhich led to a sell-off in bonds and stocks worldwide.

The central bank surprised markets by adjusting its yield curve control (YCC) policy to allow the yield on 10 years Japanese government bonds ( JGB ) are moving 50 basis points either side of the 0% target, up from 25 basis points previously, in a move aimed at dampening the impact of prolonged monetary stimulus measures.

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In a policy statement, the BoJ said the move was intended to “improve market functioning and encourage a smoother formation of the entire yield curve, while maintaining accommodative economic conditions.”

The central bank introduced its yield curve control mechanism in September 2016, with the intention of lifting inflation towards the 2% target after a prolonged period of economic stagnation and ultra-low inflation.

The BoJ – an outlier compared to most major central banks – also left its benchmark interest rate unchanged at -0.1% on Tuesday and vowed to significantly speed up its 10-year government bond purchases, keeping its ultra-loose monetary policy stance. In contrast, other central banks around the world continue to raise interest rates and tighten monetary policy aggressively in an attempt to rein in soaring inflation.

The YCC change led to Japanese yen and bond yields around the world to rise, while stocks in the Asia-Pacific fell. Japanese Nikkei 225 was down 2.5% on Tuesday afternoon. The 10-year JGB yield briefly climbed above 0.43%, the highest level since 2015.

US Treasury yields increased by 10 year note climbing by around 7 basis points to exceed 3.66% and 30-year bond increasing by around 9 basis points to 3.7%. The yield moves inversely to the prices.

Shares in Europe also retreated at the open, with the pan-European Stoxx 600 lost 1% in early trading before recovering slightly. European government bonds also sold off, with Germany’s 10-year bond yield and adds nearly 9 basis points to 2.2840%.

“The decision is being read as a sign of testing the waters, for a potential withdrawal of the stimulus that has been pumped into the economy to try to stimulate demand and wake up prices,” said Susannah Streeter, senior investment and market analyst at Hargreaves Lansdowne.

“But the bank remains firmly attached to the bond-buying program, arguing that this is just fine-tuning, not the start of a policy reversal.”

That sentiment was echoed by Mizuho Bank, which said in an email on Tuesday that the market moves reflect a sudden amount of betting on a hawkish policy pivot by the BoJ, but argued that the “popular bet does not mean that is the political reality, or the the intended political opinion.”

“In fact, there is nothing in the fundamental nature of the move or the accompanying communication that challenges our fundamental view that the BoJ will calibrate policy to relieve JPY pressure but not become overtly hawkish,” said Vishnu Varathan, head of economics and strategy. for the Asia and Oceania Treasury Department at Mizuho.

“First, every effort was made to emphasize that policy accommodation is maintained, whether this was referring to intended as well as potential escalation of bond purchases or suggesting no further YCC target band expansion (for now).”

The Bank of Japan noted in its statement that since early spring, market volatility around the world had increased, “and this has significantly affected these markets in Japan.”

“The functioning of the bond markets has deteriorated, particularly in terms of relative relationships between bond yields of different maturities and arbitrage relationships between spot and futures markets,” it added.

The central bank said that if these market conditions persist, it could have a “negative impact on financial conditions such as corporate bond issuance conditions.”

Luis Costa, Head of CEEMEA Strategy at Citiindicated on Tuesday that the market move may be an overreaction, telling CNBC that there was “absolutely nothing striking” about the BoJ’s decision.

“You have to take this BoJ target in the context of a dollar-yen positioning that obviously didn’t expect this adjustment. It’s a tweak,” he said.

Japanese inflation is forecast to come in at 3.7% annually in November, according to a Reuters poll last week – a 40-year high but still well below levels in comparable Western economies.

Costa said the Bank of Japan’s move was not aimed at fighting inflation, but addressing the “infrastructure and dynamics of JGB trading” and the gap in volatility between the trading of JGBs and the rest of the market.