BoJ Stands Pat, Will Use Funds-Supplying Operations to Tame Curve
As expected, the Bank of Japan Monetary Policy Board decided to keep interest rates unchanged. Despite huge pressure from the market, no changes were made to the 10-year peg at 0.50%. Immediately following the announcement of today’s decision, traders scrambled to cover their JGB short positions, driving the yield on the benchmark 10-year JGB to as low as 0.360% before finishing the day at a yield of 0.410%—well below the top of the trading band at 0.500%. USDJPY was heavily bought, rising two big figures in just a minute before topping out at 131.57. All in all, it was a bad day for traders betting against the Bank.
Besides the decision to leave rates unchanged, the Board released its quarterly Outlook for Economic Activity and Prices which feature the BoJ’s version of the US Fed’s “dot plot.” Here is a summary of the Board’s forecasts:
Notes: Core CPI=excluding fresh food, Core-core CPI= excluding fresh food and energy
Note that the Board is expecting a significant deceleration in GDP over the next two years which supports the idea that the impact of sharply higher imported commodity prices will begin to drop out of the year-on-year comps beginning in the January-March 2023 quarter, driving core CPI below the 2.0% target.
In the text of the Outlook, the Board suggests that wages may not rise as much as expected during the current round of negotiations, which could put even these more conservative CPI forecasts at risk. In our view, investors should key in on the ongoing wage negotiations, particularly as settlements begin to be announced in late February and early March.
Although the decision to leave rates unchanged forced traders to cover their JGB shorts, it did not address the issue of the kink in the yield curve where 8-year and 9-year yields are higher than 10-year yields. This distortion in the curve has had a negative impact on corporate bond issuance (see Sumitomo Mitsui Trust (8309) Delays 10-Year Bond Issue, Japan News Update January 17, 2023).
Having failed to correct this issue by widening the trading band back in December, the Board today decided to change the rules regarding Funds-Supplying Operations against Pooled Collateral so that loans made through these operations will be priced to reflect a normal, upward-sloping yield curve. Since the BoJ wants to drive down 8-year and 9-year rates, offering lower-cast loans to banks through Funds-Supplying Operations will help to normalize the curve without forcing the Bank to purchase large amounts of off-the-run JGBs.
Late Wednesday (Japan time) the BoJ announced the first of its Funds-Supplying Operations under the new rules. These will be five-year loans—which does not directly address the problem at eight years and nine years—but the Bank can announce loans of whatever duration suits tier purpose up to ten years.
Make no mistake—the changes to the Funds-Supplying Operations are intended to iron out the kink in the curve. The BoJ said, “The Bank shall determine the interest rate of each loan in order to encourage the formation of a yield curve that is consistent with the guideline for market operations, taking into account market prices of Japanese government bonds for each maturity.”
If the BoJ uses Funds-Supplying Operations effectively, it should help to reduce rates across the curve. Indeed, the entire yield curve did shift lower during the Tokyo afternoon session. Moreover, since JGBs are not part of the Funds-Supplying Operation, this move could start to address the chronic illiquidity of the JGB market. It is worth noting that the BoJ sold a record ¥8,398.4 billion worth of JGB repos through the Securities Lending Facility (SLF) on Wednesday.
Some observers have commented that the BoJ is panicking about maintaining Yield Curve Control (YCC) until the new governor is installed in April. There is still a lot of speculation that YCC will be lifted at the first post-Kuroda Board meeting on April 27-28. While it is still too early to say—we need to know who the next governor and deputy governors will be—the market will likely put even more pressure on the BoJ to widen the trading band around the 10-year peg as we head into the last Kuroda Board meeting on March 9-10 (there is no meeting scheduled for February).
We will be watching closely to see how the Bank uses its new strategy and how effective it will be in normalizing the yield curve.
