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BoJ faces test as yield on 10-year JGBs nears zero

The Bank of Japan faces a defining stress-test of its “yield curve control” policy in coming days as the benchmark Japanese government bond yield nears zero and currency markets recalibrate themselves for a Donald Trump US presidency.

With post-election yen volatility already making a mark on Japanese equities, traders in Tokyo said the focus would this week turn on JGB markets and the BoJ’s resolve.

After wrestling to understand the implications of Mr Trump’s various, sometimes conflicting campaign pledges, markets are tentatively pricing in large-scale fiscal stimulus — policies that could see the yen weaken against a background of a resurgent dollar and rising Treasury yields.

For Japanese analysts the key question will be how BoJ governor Haruhiko Kuroda will respond if 10-year JGB yields rise to zero or even put them in positive territory for the first time since March. Critical to making that happen, say analysts, will be whether the yen falls to ¥110 per dollar — its level the previous time the 10-year JGB yield closed above zero.

The uncertainty that the BoJ might soon be forced to clear up, said Nomura’s rates analyst Naka Matsuzawa, is what level Mr Kuroda is targeting through yield curve control. Some suspect that he sees a 0.0 yield on the 10-year JGB as the ceiling, others that zero represents the centrepoint of a range around which the BoJ could be flexible.

Warnings of an impending stress test along those lines intensified on Friday when, following the yen’s decline to ¥107 against the dollar, the yield on the 10-year JGB rose to an intraday peak of minus 0.025 per cent. Shuichi Ohsaki, Japan fixed income strategist at Bank of America Merrill Lynch, said that if US treasury yields were still rising next week there was a chance that the JGB 10-year yield could touch zero soon.

But its stay there would likely be temporary. The 10-year JGB’s arrival at a yield of zero, said Mr Ohsaki, would unleash massive, pent-up demand from many investors, but particularly from Japan’s regional banks. Since 10-year JGB yields turned negative earlier this year, regional banks have been forced to chase yield from much longer tenors: the weight of buying pressure at 0.0 per cent yields would send them lower again.

JGB yields stand the closest to zero they have been since September 21 — the BoJ meeting where Mr Kuroda introduced the concept of “quantitative and qualitative monetary easing with yield curve control”. Once the dust had settled after that meeting, analysts interpreted the move as a signal to markets that the potential for BoJ intervention in JGB markets was, in theory, unlimited.

The post-election bond sell-off in the US and Japan, said CLSA global strategist Christopher Wood, raises the possibility of a stress test of the BoJ’s commitment to fix the ¥10-year JGB yield at 0.0 per cent. “A move in the 10-year Treasury bond yield through 2.25 per cent, say, is the kind of market move that could trigger such a stress test,” he wrote in a note to clients last week. “That in turn would mean the BoJ being seemingly committed to unlimited JGB purchases which would be yen bearish and Japanese equity bullish.”

Nomura’s Mr Matsuzawa, however, noted that while JGB yields of minus 0.025 per cent look close to zero: “Those three basis points hold quite a lot of meaning. Everyone knows that as they get closer [to zero], investors would shift to get the yield,” he said.

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