It didn’t take much to reveal just how fearful global markets are about a change in Japan’s ultra-loose monetary policy.
(Bloomberg) — It didn’t take much to reveal just how fearful global markets are about a change in Japan’s ultra-loose monetary policy.
News the Bank of Japan was mulling a hawkish tweak to years of capping bond yields ignited a small-scale tempest across US markets Thursday. Treasury yields spiked, the yen rallied, and US stocks swung to a loss. Shaken markets continued to gyrate after the BOJ outlined the changes Friday.
Pain is spreading across a number asset classes as traders come to grips with the fact the last major central bank to resist restrictive policy appears to be caving in. Japanese markets are at the center of various international trades that exploit its rock-bottom interest rates, and bulls also worried about a repatriation of trillions of dollars of funds should those rates in the Asian country start to rise.
“The yield-curve-control tweak in all but name will drive the yen stronger in the remainder of the year,” said Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management in Singapore. “Higher Japanese rates could have a ripple effect across other major fixed income markets with sizable shares of Japanese bond holdings,” such as in French and Australian debt, he said.
Global bonds took another leg lower Friday after the BOJ unexpectedly signaled it would allow yields to climb above its previous cap. The central bank maintained its target for 10-year yields at around 0% but said the 0.5% ceiling was a reference point, not a definite limit as it aimed to make its easing program more flexible.
Japanese 10-year yields jumped as much as 13.5 basis points to 0.575%, while yields also climbed for US Treasuries and Australian sovereign debt. Japanese stocks were among the worst performers in the region after the decision.
‘Selling Pressure’
The BOJ’s move “will be interpreted by Treasury investors as a selling pressure because Japan’s government bond yields will likely move higher,” said Gordon Tsui, managing director and head of fixed income of Ping An of China Asset Management (Hong Kong).
Japanese investors are the biggest holders of Treasuries outside the US. They were also owners of about 10% of Australian debt and Dutch bonds, 8% of New Zealand’s securities and 7% of Brazil’s debt, according to calculations by Bloomberg based on data through the end of March.
Still, BNY Mellon’s Mitra also said the selloff in sovereign bonds in other countries may not be prolonged. That’s because the total stock of Japanese holdings of foreign debt already dropped last year by nearly 30%, he wrote in a statement.
Much of the tension is related to currency market, where investing playbooks have been built on the BOJ’s easy monetary policy. In recent years the yen has become the funding instrument of choice for so-called carry trades, in which investors borrow in a low-yielding currency to finance purchases of higher-yielding assets.
BOJ Headwind
The BOJ’s decision “acts as a headwind at the margin for long-duration US bonds and equities,” said Paras Anand, chief investment officer of Artemis Investment Management. “It similarly continues to weaken the attraction of yen funded carry trades, and arguably carry trades in general as the upward pressure on rates becomes more widespread.”
Read more: A $3 Trillion Threat to Global Financial Markets Looms in Japan
The yen whipsawed immediately after the BOJ’s move as investors assessed the impact of its new stance, with carry traders in particular bracing for a sustained strengthening move.
“Politically, the excessive weak yen and higher inflation has been a thorn in the side of policymakers,” said Mark McCormick, head of foreign exchange and emerging-market strategy at Toronto Dominion Bank in Toronto. “The tweak is just another piecemeal step policy normalization, which is likely to increase market interest in further normalization down the road.”
–With assistance from Isabelle Lee, Emily Graffeo, Carter Johnson, Iris Ouyang, Nurin Sofia, Tassia Sipahutar and David Finnerty.
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