Bond Selloff Blocked by BOJ While Officials Monitor Yen’s Slide

Policymakers in Japan on Tuesday sought to balance a commitment to ultra-loose monetary policy in a world of rising interest rates without letting the yen tumble further toward a 20-year low.

While the Bank of Japan was buying sovereign bonds, the finance ministry fired a warning shot to traders looking to put further pressure on the Group-of-10’s worst-performing currency. The double act capped benchmark bond yields and helped steady the yen.

“The BOJ reiterated its strong resolve to not allow 10-year yields above 0.25%,” said Naomi Muguruma, a senior market economist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo.

Investors sold 528.6 billion yen ($4.3 billion) of bonds to the central bank in two operations in the first of a three-day plan for unlimited purchases of benchmark notes. Ten-year yields dipped though longer-dated debt outside the BOJ’s control was still seen as vulnerable amid the steepest global bond rout of the modern era. The yen edged higher.

The amount spent in today’s transaction pales in comparison to previous BOJ bond buying exercises. In July 2018, it bought 1.6 trillion yen in five-to-10 year maturities to keep yields down.

The unprecedented intervention in bond markets started to bear fruit as officials stepped up warnings of the negative economic impact of a tumbling yen. Japan’s chief currency official Masato Kanda said he and his U.S. counterpart discussed exchange rates Tuesday, a day after the yen breached the 125 mark against the dollar for the first time in seven years. 

“We discussed various global issues including debt problems and the Russian sanctions and support for Ukraine,” said Kanda, speaking to reporters after meeting with Andy Baukol, the U.S. Treasury Department’s undersecretary for international affairs.

BOJ Steps Into Market to Cap Yields Amid Global Bond Selloff

The central bank intervened in an extraordinary manner Monday after the global bond slump pushed benchmark yields to the upper end of its 0.25% line in the sand. Officials remain committed to keeping policy loose to boost Japan’s moribund economy even as surging inflation worldwide has spurred peers such as the Federal Reserve to roll back stimulus and raise interest rates.

The BOJ conducted two unlimited purchase operations Monday -- and announced plans for more through Thursday -- a move which sent the yen plummeting to a seven-year low. It is the first time the central bank has intervened over such a sustained period.

Yen Tumbles to Seven-Year Low as BOJ Diverges Further From Fed

The move underscored Governor Haruhiko Kuroda’s resolve to keep 10-year yields capped at 0.25% in a bid to boost inflation which remains far from a 2% target. But it has failed to push yields significantly lower -- the 10-year traded at 0.245% on Tuesday.

“The amount of the takeup won’t make the BOJ nervous,” said Kyohei Morita, chief Japan economist at Credit Agricole Securities Asia. “The market rates are close to BOJ’s ceiling, unlike before, and it seems that the BOJ’s message is that it’s fine to reach 0.25% but it won’t let the rates stay above that level.”

Bond traders are starting to understand that, which is one of the key reasons takeup increased from yesterday, he added.

While the 10-year benchmark is capped, the BOJ has let super-long yields rise, saying too low levels in these sectors would be negative for investors and the economy. The 30-year yield breached 1% Monday for the first time in six years.

The central bank is unlikely to conduct fixed-rate operations in other sectors as it would send too strong a signal on yield levels the BOJ isn’t controlling, wrote Citigroup’s Tomohisa Fujiki in a note Monday. That means if the Japanese yield curve diverges from fair value, volatility could increase when the BOJ actually exits from the current framework, he said.

“We are probably starting to see the limit of the yield curve control program,” said Takahiro Sekido, chief Japan strategist at MUFG Bank and a former BOJ official. The ‘slew’ of actions “suggests that the yield curve control can’t be carried on as it is now. They may have to make it more flexible or may need to tweak it.”

The BOJ action has spilled into the currency market sending the yen to a seven-year low this week and sparking chatter of further intervention, this time from the government. Japan is caught between a dovish BOJ and a hawkish Federal Reserve which has widened the yield gap between the two countries and pushed down the yen.

The volatility in Japan resembles that seen in the Australian market late last year when the central bank there was forced to abandon its curve control policy due to a surge in yields.

“The FX market is pricing increased policy divergence between Japan and the rest of the world, but the rates market is starting to doubt how long this can last,” said George Saravelos, Deutsche Bank’s global head of currency research in London. “Either Japan will finally ‘make it’s out of deflation by tolerating a more sustained currency overshoot, or the BOJ will have to ‘break it and abandon yield curve control just like the RBA did last year.”