The Bank of Japan’s looser grip on benchmark 10-year yields is starting to shake up the outlook for short-term borrowing costs, with swaps traders betting that the central bank will end the world’s last negative interest rate policy in as little as eight months.
(Bloomberg) — The Bank of Japan’s looser grip on benchmark 10-year yields is starting to shake up the outlook for short-term borrowing costs, with swaps traders betting that the central bank will end the world’s last negative interest rate policy in as little as eight months.
This signals a profound change for investors in Japanese markets, which have labored under the policy since early 2016, when former governor Haruhiko Kuroda doubled down on a zero rates regime that had been in place on-and-off since 1999.
After years of being wrong-footed by the BOJ, investors aren’t taking its new chief Kazuo Ueda and his board at their word. Wagers on the demise of negative rates have been brought forward to March next year from July. Overnight indexed swaps suggest the short-term policy rate may rise above 0.1% by the end of September 2024.
While the central bank indicated that its surprise move to give 10-year rates room to rise to 1% was designed to make yield-curve control more flexible, managing this process may force it to make purchases that sap liquidity and distort the market. This contradiction undermines its argument in the eyes of some investors, who see policy makers under pressure to raise rates as inflation starts to take hold in Japan.
An end of the negative rate policy would likely support the beleaguered yen, and also ease financial burdens on commercial banks, which have to pay interest to the BOJ when parking excess funds there. It would also complement the shift higher in yields on longer-term Japanese government bonds, which increases the incentive for the nation’s large institutional investors to sell assets such as US Treasuries and bring more funds home.
“As 10-year yields get freed up, market participants are gradually shifting focus to short rates,” said Eugene Leow, fixed-income strategist in Singapore at DBS Bank Ltd. “The focus on short rates is a natural progression once YCC gets dismantled, something that might take place in 2024.”
Ueda has said the adjustment made on July 28 isn’t a move toward ending YCC, and Deputy Governor Shinichi Uchida has indicated that the BOJ is still far from raising its negative interest rate. But Leow said the market is skeptical and clearly sees policy as moving in that direction.
The 10-year yield climbed to 0.655% last week, the highest since 2014, with the central bank forced to intervene twice with unscheduled bond-buying to curb the speed of the moves. The rate on 30-year debt, which Japanese life insurance companies typically hold, reached a near seven-month high of 1.63% last week.
Investors continue to hedge against further gains in 10-year yields, with overnight indexed swaps for this maturity standing at 0.76%. That’s about 15 basis points higher than the yield on the benchmark bond, though still below the BOJ’s new effective ceiling of 1%.
Investors have also been bidding up the stocks of commercial banks since Ueda’s tweak on expectations that margins on lending will widen as rates rise. A gauge of equities in the sector up about 4% since the day before the change, versus a small decline in the broader Topix index.
Online lender Rakuten Bank Ltd. said a rise in short-term rates would have an immediate benefit for its business, given that many of the loans and other assets on its books have adjustable rates.
“So for us, the end of the negative interest rate policy means a big increase in profits,” said Chief Executive Officer Hiroyuki Nagai, adding that he considers his business to be better positioned than its rivals.
“We have penciled in the possibility that the BOJ will raise the policy-rate balance rate from minus 0.1% to zero by the end of this year, if not then early next year,” said Frances Cheung, a rates strategist at Oversea-Chinese Banking Corp. in Singapore. “The negative-rate policy may no longer be appropriate given the inflation backdrop.”
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