Japan Raises 10-year Bond Yield Limit, Signaling Possible Shift in Monetary Policy

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The Bank of Japan announced on Dec. 20 that it was raising the ceiling on its 10-year government bond yield from 0.25 percent to 0.5 percent. Japan’s economic average plunged that afternoon, and the Japanese yen rose in response, signaling investors that the last country with negative interest rates was going to start ending its loose monetary policy.

Once the monetary policy meeting ended, the Bank of Japan released its monetary policy statement on Dec. 20, announcing that it would keep the interest rate unchanged at -0.1 percent and keep the yield on 10-year Japanese government bonds at around zero percent, but the policy expanded the floating range of its yield from plus or minus 0.25 percent to plus or minus 0.5 percent, meaning that the upper limit of the 10-year bond yield was raised to 0.5 percent.

The Treasury yield is the reference rate for corporate bond yields, bank lending rates, and other funding rates. The statement said that the volatility in overseas financial and capital markets has greatly affected Japan, and the bond market has deteriorated, especially in response to arbitrage in different bonds. The Bank Policy Committee decided to revise the Yield Curve Control (YCC) for government bonds in order to improve market functions.

After the Bank of Japan released this statement, Japan’s 10-year bond yield once soared 21 basis points to 0.467 percent, the highest value since 2015; Nikkei 225 resumed trading in the afternoon and plunged at one time by nearly 900 points. The next day, the downward trend continued, and the closing value of the Nikkei 225 on Dec. 21 fell another 180 points from the closing value on the 20th. Nikkei 225 is an important reference for investing in Japan and is the longest-running and most well-known stock price index in Japan.

As the Japanese stock market plunged, the value of the Japanese yen rose, and the dollar-yen curve fell off a cliff on Dec. 20, dropping from nearly 137 a few days earlier to below 132, the lowest in nearly four months.

Mike Sun, a North American investment strategist and China expert, told The Epoch Times on Dec. 21, “The market is interpreting the Bank of Japan’s marginal adjustment as a push for a return of capital and a stronger yen amid a global wave of interest rate hikes.”

Japan has maintained a relaxed monetary policy, contrary to the practice of other developed countries that have continued to raise interest rates since this year. For example, the Federal Reserve raised interest rates by 50 basis points in December after four consecutive 75 basis point hikes. The UK completed its eighth rate hike this year on Dec. 15, raising rates to a 14-year high of 3.5 percent. Canada raised rates seven times in a row in 2022, and the European Central Bank raised rates four times in a row.

Although Bank of Japan Governor Haruhiko Kuroda emphasized at a press conference that the decision was not a rate hike, investors interpreted the change as an indication that Japan is starting to exit the relaxed monetary policy.

Importance of the 10-Year Treasury Yield

The market’s risk-free yield generally refers to the yield on 10-year bonds, which is the benchmark for valuing various assets. For example, the yield on the 10-year Treasury bond is used to calculate the equity-to-debt ratio, which is the ratio of earnings yield to the market risk-free rate of return.

If the return on an asset is lower than the market’s risk-free return, investors will sell the asset and buy 10-year Treasury bonds. Conversely, if the return on an asset is higher than the return on a 10-year bond, investors will choose to sell their 10-year bond holdings and buy the asset.

The Bank of Japan’s adjustment of the upper limit of the 10-year bond yield is equivalent to an upward adjustment of the market’s risk-free yield, thus causing the stock market to plunge. As the yield on government bonds and the price of government bonds are inversely related, the increase in the ceiling of the 10-year yield on government bonds also caused the Japanese government bonds to plummet.

In addition, the Japanese yen is an arbitrage currency, as it has low long-term interest rates and is highly liquid, so investors earn spreads by borrowing low-interest yen to buy higher-interest currencies. The Bank of Japan’s adjustment of the ceiling on 10-year government bond yields, resulting in a sudden appreciation of the yen, will disturb world financial markets.

The Bank of Japan’s surprise increase in the 10-year yield ceiling is related to high global inflation, as Japan’s consumer price index (CPI) has exceeded its stated target of 2 percent amid global inflation.

Imported Inflation Impacts Japan

Japan has kept interest rates low for a long time in response to deflation. Deflation refers to a general decline in prices and costs as the supply of goods and services exceeds demand due to a reduction in the supply of money under prevailing price conditions. The CPI chart released by the Bank of Japan in November showed that Japan’s CPI was below the 2 percent target for the period 2007 to 2021.

In the monetary policy statement released on Dec. 20, the Bank of Japan said that it would continue to implement the YCC’s quantitative and qualitative monetary easing policy to ensure inflation remains above 2 percent in a stable manner.

The statement said: “Japan’s personal consumption growth was low due to the pandemic. Housing investment was weak, public investment was largely flat, and monetary liquidity was generally accommodative, although corporate financial conditions remained weak in some areas. The Consumer Price Index (CPI), which excludes fresh food, has risen to 3.5 percent, exceeding the 2 percent inflation target, due to rising prices of energy, food, and durable goods.”

Japan has been under pressure from imported inflation so far this year. The inflation rate in the UK was 10.7 percent in November and 7.1 percent in the United States on Dec. 13. For Japan, the prices of imported goods are rising sharply, while the U.S. dollar has raised interest rates, causing other currencies to depreciate, especially the Japanese yen, which in turn has pushed up the prices of its imported goods.

On Sept. 1, the U.S. dollar broke 140 to the Japanese yen, the lowest price in 24 years. Nikkei News reported on Sept. 2 that the yen fell too low, and the pulling power of the Japanese economy weakened. After the Bank of Japan raised the yield ceiling for 10-year government bonds on Dec. 20, the U.S. dollar fell to 132 to the yen on Dec. 22, down from about 137.

Japan is also the world’s largest creditor. The U.S. Treasury Department released data on Dec. 15 showing that Japan’s holdings of U.S. Treasury bonds still ranked first, but has reduced its holdings for four consecutive months, holding $1.078 trillion in U.S. Treasury bonds in October, the lowest value in three and a half years.

According to Wells Fargo analysts Erik Nelson and Jack Boswell, Japanese investors have been net sellers of foreign bonds throughout 2022, and the Bank of Japan’s decision on 20 Dec. will reinforce the trend that foreign bonds are becoming less attractive compared to Japanese government bonds.

Mike Sun said: “With the Fed slowing down rate hikes, the Bank of Japan still has room to adjust monetary policy in the future. The yen’s strength is likely to continue for some time. Financial institutions that decided to short the yen will have to face huge losses. International capital continues to bet on Japan to raise the yield on its 10-year government bonds next spring.”