Bank of Japan fiddles as bond market burns


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

Kuroda’s interventions to put a floor under the falling yen, which at nearly 150 to the US dollar is at its weakest level since 1990, appear to be losing ground. He could make changes to the bank’s unorthodox monetary policy, but they might not accomplish much given the fundamentals. The root of the problem is the deep chasm between American and Japanese economic conditions.

With consumer costs soaring in Western economies, the Federal Reserve has raised borrowing rates, but in Japan inflation remains relatively low and growth sluggish. September economic data for Japan was bleak, with a rising import bill and slowing factory activity. Credit austerity could profoundly inhibit economic activity.

Annual consumer inflation, at 3%, is subdued by global standards, but it’s not the kind of demand- and wage-led price hikes the Bank of Japan has tried to provide. Instead, it reflects temporary increases in food and energy costs. Tokyo is therefore trying to stick to Plan A and keep its fares ultra low. In the meantime, officials hope a $65 billion stimulus package announced on Friday will paradoxically cool the consumer price index by more than a percentage point via subsidies for electricity and utility bills. ‘essence ; we are talking about reducing consumption taxes.

But given that 10-year US bonds are yielding 4% while their Japanese equivalents are paying next to nothing, investors unsurprisingly moved money into dollar assets and out of the yen, prompting Kuroda to step in. unwillingly. The biggest problem, however, is in the bond market.

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

The central bank could change its policy by targeting a shorter duration, for example. But with the whole curve going up, it’s hard to believe it would make much of a 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 about half of the total sovereign market; its holdings of long-term government bonds increased to 560 trillion yen ($3.8 trillion) in 2022 from 40 trillion yen in 2008.

A deep and liquid sovereign pool is essential 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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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 during of fiscal year 2023. One official said the measures would also suppress consumer price inflation by around 1.2 percentage points. The annual consumer inflation rate in Japan was 3% in September.

The country’s import bill rose more than 40 percent for a fifth consecutive month to the highest value on record, as the falling exchange rate worsened fuel import costs. Factory output fell for the first time in four months as manufacturers were hit by rising raw material costs and the global economic slowdown.

Reuters calculations and data from the US Commodity Futures Trading Commission show the net short position in the yen soared to 102,618 contracts, the highest level since May. The Bank of Japan began intervening in currency markets as the yen slipped toward 150 to the dollar, a drop caused by widening interest rate differentials 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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