The Bank of Japan’s Battle to Cap Bond Yields

The Bank of Japan and the Japanese government bond market are poised to battle for control over yields on the 10-year government bond benchmark as the Bank of Japan resolves to curtail rises in long-term debt yields in the market.

The diminishing popularity of Prime Minister Shinzo Abe, where approval for Abe's government fell to 29.9 per cent according to a recent poll for the Jiji news agency, coupled with prevailing global sentiment both threaten to move interest rates higher. Investors are cognizant that rising bond yields globally could ripple across Japan’s Government Bond market pitting the Bank of Japan against market forces it has minimal control over.

The Central Bank committed last Friday to a program of unlimited open market purchases of Japanese government bonds in order to defend its recent policy implementation of holding the 10 year benchmark at 0.0 per cent, deploying one of the most powerful monetary policy tools the Bank has in its arsenal. BoJ governor Haruhiko Kuroda’s decision has subsequently weakened speculation that the central bank might raise its intervention point incrementally from 0.11 per cent to 0.2 per cent.

According to analysts such an increase would likely constitute an inflection point that would revive investor interest in Japan’s ailing banking sector. Ben Summers, Head of Fixed Income at Company ABC, said of the cap that it “makes a bearish outlook on the bank stock a compelling narrative.”

The BoJ have committed to buying ¥80tn of sovereign debt by year end, a commitment that has been questioned internationally. This runs contrary to contractionary monetary policy which is more prevalent in other developed economies. The US Federal Reserve is beginning to raise interest rates and the ECB have signaled that tapering of their expansive bond-buying program is imminent.

To this point, however, it is important to understand prevailing macroeconomic conditions in Japan show marked differences to their European or US counterparts. “Persistently low inflation and wage increase resistance in the Japanese market make movements towards monetary policy normalization an impossibility” according to Company ABC economist Stephen Bernanke.

Political instability in Japan is also working to exacerbate this problem. The sustainability of the BoJ’s aggressive monetary policy stance is largely dependent on Abe and Kuroda, who have experienced sudden declines in their support, putting into question the longevity of their terms in office and by extension the policies they have enacted.