In a move that has sent ripples through the bond and currency markets, the Bank of Japan (BOJ) subtly adjusted its language today.
Following the announcement by the BOJ, the yield on 10-year Japanese bonds soared to 0.572%, marking a nine-year peak. The yen appreciated by 1.2%, reaching a high of 138.05 yen per US dollar, before giving back most of its gains to stand at 140.51 yen per dollar.
Moreover, signs of a reversal in the BOJ's policy could mean that Japanese banks are set to regain lending profits. Consequently, Japanese bank shares surged by 4.6% today, reaching an eight-year high.
Internationally, several countries' benchmark bonds plunged in response. Australia's 10-year bond yield rose by 14 basis points, while South Korea's 2033 bonds climbed 10 basis points to 3.76%, the highest since March. South Africa's 2035 rand bonds saw their yields rise by 11 basis points, the highest in two weeks.
The potential strengthening of the yen has reduced the attractiveness of forex carry trades, leading to a decline in most emerging market currencies used in these transactions. The MSCI emerging market currency index fell as much as 0.4%, erasing more than half of this week's gains, with Asian currencies leading the decline.
For years, the BOJ's ultra-loose policy has made the yen a primary source of financing for carry trades. Forex investors typically choose to borrow in cheap yen to buy high-yielding assets overseas in emerging market countries with high inflation for arbitrage.
Furthermore, Japan has been the world's largest creditor nation since 1992, with the US, France, and the UK being its top three debtor nations. Also, Japanese funds have made significant investments in areas such as European power plants and high-risk loans.
BOJ's Surprise Move
Today, the BOJ announced that the target range for 10-year Japanese bond yields would remain at around ±0.5%. However, it stated that it would flexibly control the 10-year government bond yield, and it plans to purchase 10-year government bonds at a yield of 1% on each working day, rather than the previous 0.5%.
This is being interpreted externally as the BOJ's plan to reverse the loose policy it has maintained since 1999. Market participants generally agree that the BOJ's hawkish language indicates that it may, like other central banks of major economies, tighten monetary policy to counter inflation.
Since the beginning of this century, the BOJ has initiated Quantitative Easing (QE), and since 2013, under the influence of "Abenomics", it has implemented a series of unconventional ultra-loose monetary policies. Among major global economies, Japan is currently the only one still persisting with negative interest rates and using yield curve control to regulate long-term government bond interest rates.
Therefore, any hint of change in BOJ's policy can have significant implications for the global financial market. If the BOJ truly abandons its Yield Curve Control (YCC) policy, allowing the yen to rise and prompting outflowing Japanese household assets to flow back into the country, it could result in a financial earthquake.
Carlos Casanova, Senior Asia Economist at UBP in Hong Kong, commented that although the BOJ maintains an 'around 0.50%' upper limit, the subtle change in its wording indicates that they are preparing or, at the very least, open to adjusting the YCC target at a future date if conditions are favorable. Tom Nash, an investment portfolio manager at UBS Asset Management in Australia, believes that the BOJ has taken a "significant step towards ultimately dissolving the YCC."
