Bank of Japan fiddles while bond market burns

Students play violins at the Suzuki Method Grand Concert in Tokyo March 28, 2007. About 3,000 students played violins, cellos and flutes in the concert. REUTERS/Kim Kyung-Hoon

HONG KONG, Oct 31 (Reuters Breakingviews) - Bank of Japan (8301.T) Governor Haruhiko Kuroda is playing with forex fire. The yield-curve control policy in which the central bank attempts to hold down interest rates by buying – or threatening to buy - unlimited amounts of sovereign bonds, is breaking down and risks freezing the market over, a bad look for an international reserve currency.

Kuroda’s interventions to put a floor under the plunging yen, which at nearly 150 per U.S. dollar is at its weakest since 1990, appear to be losing traction. He could make tweaks to the bank’s unorthodox monetary policy, but they might not accomplish much given fundamentals. The root of the issue is the profound gap between American and Japanese economic conditions.

With consumer costs spiking in Western economies, the Federal Reserve has been hiking borrowing rates, but in Japan inflation remains relatively tepid and growth anemic. September economic data for Japan was grim, with the import bill spiking and factory activity slowing. Credit austerity could profoundly inhibit economic activity.

Annual consumer inflation, at 3%, is subdued by global standards, but it is not the kind of demand- and wage-driven price rises the Bank of Japan has been trying to deliver. Instead, it reflects temporary rises in food and energy costs. So Tokyo is trying to stick with plan A and keep its rates ultra-low. In the meantime, officials hope a $65 billion stimulus package announced Friday will paradoxically cool the consumer price index by over a full percentage point via subsidies for electricity bills and petrol; there is talk of slashing consumption taxes.

But given 10-year U.S. bonds yield 4% while their Japanese equivalents pay next to nothing, investors have unsurprisingly moved money into dollar assets and out of yen, prompting Kuroda to reluctantly intervene. The bigger problem, however, is in the bond market.

While Kuroda has enough firepower to keep the 10-year Japanese government bond yields below the self-imposed 0.25% cap, the market has pushed up yields along the rest of the curve; the 8-year now yields more. Traders are repeatedly testing the cap on the 10-year, and short positions against the yen are at their highest since May.

The central bank could tweak its policy by targeting a shorter tenor, for example. But with the entire curve creeping upwards, it’s hard to believe this would make much difference. And as Kuroda tries to force the market to trade sovereign bonds at rates investors don’t want, liquidity is drying up. The central bank already owns roughly half of the total sovereign market; its holdings of long-term government bonds have risen to 560 trillion yen ($3.8 trillion) in 2022 from 40 trillion yen in 2008.

A deep, liquid sovereign pool is critical to the functioning of any international currency, and the yen, thanks to its low borrowing rates and easy convertibility, is one of the most popular. Passivity could do permanent damage to the yen’s global stature.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

CONTEXT NEWS

Japan on Oct. 28 unveiled a stimulus package with spending worth 39 trillion yen ($265 billion) that it said would boost gross domestic product by around 4.6%, mostly in fiscal year 2023. An official said the measures also would suppress consumer price inflation by around 1.2 percentage points. Japan’s annual consumer inflation rate was 3% in September.

The country’s import bill grew more than 40% for a fifth straight month to hit the largest value on record, as a slumping exchange rate aggravated fuel import costs. Factory output fell for the first time in four months as manufacturers took a hit from rising costs for raw materials and the global economic slowdown.

Calculations by Reuters and U.S. Commodity Futures Trading Commission data show net short positioning on the yen has ballooned to 102,618 contracts, the highest level since May. The Bank of Japan has begun to intervene in currency markets as the yen slides toward 150 per dollar, a plunge caused by widening interest rate spreads between the United States and Japan. The yen is currently at its weakest level since 1990.

Editing by Una Galani and Thomas Shum

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Asia Economics Editor Pete Sweeney joined Reuters Breakingviews in Hong Kong in September 2016. Previously he served as Reuters' chief correspondent for China Economy and Markets, running teams in Shanghai and Beijing; before that he was editor of China Economic Review, a monthly magazine focused on providing news and analysis on the mainland economy. Sweeney came to China as a Fulbright scholar in 2008, and in that role conducted research on the Chinese aviation industry and outbound M&A. In prior incarnations he helped resettle refugees in Atlanta, covered the European Union out of Brussels, and took a poorly timed swing at craft-beer entrepreneurship in Quito even as the Ecuadorean currency collapsed (not his fault). He speaks Mandarin Chinese, at the expense of his Spanish.