LDN - Business

Fed's path piles pressure on Japan's bond yield control policy

[March 17, 2017] By Hideyuki Sano

TOKYO (Reuters) - The Bank of Japan's ambitious yield curve control policy is under attack from rising global bond yields and volatility, and analysts say the Federal Reserve's monetary tightening cycle could force Japan to abandon it sooner rather than later.

It's barely been six months since the policy's introduction, and the central bank this week pledged to stick with buying large amounts of Japanese government bonds to keep the 10-year yield near zero.

Yet the volatility and the sudden steepness of the Japanese government bond yield curve for longer maturities show the challenge it faces.

The BOJ policy "is looking rather odd against the current backdrop", Rabobank said in a note on Friday.

While many investors see no quick change in policy, others expect the rise in global yields over the past six months means the BOJ will have to abandon or change the yield peg, reflected in the 10-year yield sitting at the upper end of its loosely defined target.

"The fact that the 10-year yield is stuck near 0.1 percent despite the BOJ's buying suggests many market players are feeling some sort of discomfort with this policy," said Jun Fukashiro, head of fixed income investments at Sumitomo Mitsui Asset Management.

"If the BOJ could keep printing money eternally, it could stop yields from rising, but markets know it is difficult to control bond yields. At some point, it will be brought to a dead end."

And a major change since the policy was introduced is the marked shift in investor sentiment towards debt around the globe as investors bet the U.S. President Donald Trump's policies will spark both growth and inflation.

Indeed, with the BOJ now suppressing the 10-year yield, the spread between 10-year U.S. and Japanese government bonds has widened to around 250 basis points, near its widest since 2010.

STEEPENING BETS

BOJ Governor Haruhiko Kuroda said on Thursday that the yield curve control policy was functioning well and he saw no need to revise the target.

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When he unveiled it in September, many JGB yields were negative and it seemed a deft move. A steeper curve would ensure other longer-term lending rates remained positive and would help the financial sector's profitability.

But the shift in global markets since then means one impact of the BOJ's focus on capping the 10-year yield has been to exacerbate volatility in other maturities.

The volatility in monthly performance in the Nomura BPI, a widely used index that tracks JGB price moves, has risen to the highest level since 2010, said Kenichi Hirayama, chief strategist at Tokio Marine Asset Management.

Over the past six months, the 40-year yield has risen 43 basis points to 1.015 percent and the 30-year yield has climbed 32 basis points to 0.835 percent.

KINK IN THE CURVE

But the 10-year yield has risen just 13 basis points. And when it hit a one-year high of 0.15 percent on Feb. 3, the BOJ announced a special operation to rein in the yield.

The result has been a major kink in the yield curve, with 10-year bonds trading perennially expensive while other maturities, especially long-dated bonds, becoming cheaper in line with U.S. and European bond trends.

The "curve steepener" trade has become a huge hit with local investors and global bond fund managers as they bet the BOJ is not that determined to cap yields beyond the 10-year mark.

"Although investors are stepping back from potentially shorting the 10-year, the yield curve steepener is very popular at the moment," said Mark Nash, head of global bonds at Old Mutual Global Investors, which manages £29 billion ($36 billion) of assets.

"They have made it clear that they like a steeper curve. And, if we're getting to general positivity across the world in terms of reflation and also a weaker yen, it makes sense to hold the 10-years and short the longer end of the JGB curve."

(Reporting by Hideyuki Sano; Editing by Vidya Ranganathan and Richard Borsuk)

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