Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
You can access both of our platforms from a single Saxo account.
Bank of Japan Adopts Flexible Approach to Yield Curve Control with Implications for the Japanese Yen
Redmond Wong
Chief China Strategist
Summary: The Bank of Japan (BoJ) maintained its yield curve control (YCC) target for 10-year Japanese Government Bonds with a range of plus and minus 50 basis points around zero at the July monetary policy meeting. However, it introduced a more flexible approach, allowing deviations from the target range and setting a 1% cap on the maximum rise in the 10-year JGB yield. The BoJ retains discretion for bond buying between 0.5% and 1%. Market confusion ensued, but the BoJ's gradual departure from the YCC policy indicates potential implications for the Japanese Yen's strength and USDJPY exchange rate.
Bank of Japan's July Monetary Policy Meeting
In a highly anticipated monetary policy meeting, the Bank of Japan (BoJ) decided to maintain its yield curve control (YCC) target, keeping it in a range of plus and minus 50 basis points (0.5 percentage points) from zero percent on the 10-year Japanese Government Bonds (JGBs). However, what caught the attention of market participants was the central bank's announcement of a significant shift in its approach, signaling greater flexibility and introducing the possibility of tolerating deviations within an unspecified extent.
BoJ's Shift in Policy Approach
Gone are the days when the BoJ adhered strictly to rigid limits for the YCC target range. Instead, it has adjusted its policy that the upper and lower bounds of the YCC target range are now mere reference points. The central bank tweaked its long-held YCC policy to give itself newfound flexibility and leeway to maneuver its monetary policy in response to prevailing economic conditions.
BoJ's New Bond Buying Arrangement
One concrete step taken by the BoJ to demonstrate this shift away, particularly from the upper bound, is the introduction of a hard stop on the maximum rise in the 10-year JGB yield at a much higher level of 1%. The central bank will now offer to purchase 10-year JGBs at a rate of 1% every business day through fixed-rate purchase operations, effectively capping the maximum increase in the 10-year JGB yield at 1%.
Cross the River by Feeling the Stones
This move, however, gives the BoJ the discretion to intervene in bond buying between 0.5% and 1%, depending on its assessment of the then-prevailing economic landscape and market conditions. The BoJ apparently is cautious in exiting the YCC completely as it notes in its Statement on Monetary Policy that “sustainable and stable achievement of the price stability target of 2 percent, accompanied by wage increases, has not yet come in sight.” The BoJ says that it will continue to do quantitative easing (QE) “until the year-on-year rate of increase in the observed CPI (all items less fresh food) or core CPI exceeds 2 percent and stays above the target in a stable manner”.
In its Outlook for Economic Activity and Prices (July 2023), the median forecasts from the Policy Board Members on the CPI (all items less fresh food) for the fiscal year ending March 2024 was revised down to +1.9% from +2.0% (forecast made in the Outlook in April) and the forecast for the fiscal year 2025 stayed at +1.6% (Figure 1), both below the +2% target.
Forex Market Reaction
The initial reaction in the forex market was one of confusion about the message sent by an unchanged target range and the BoJ's discretion to maneuver long-term interest rates between 0.5% and 1%. It resulted in choppy swings of USDJPY between 141 and 138 within the first hour of trading after the policy announcement. Adding further to the confusion, BoJ Governor Ueda downplayed the significance of the changes and insisted that the policy shift was not a step toward the normalization of monetary policy.
Interpretation and Market Impact
Nonetheless, we believe that the BoJ's actions today signal a gradual departure from the YCC policy framework. While Governor Ueda's remarks calmed the forex market and brought the USDJPY back to 139.40, flat to its closing level last night in New York (Figure 2), the central bank appears to be taking a measured and controlled approach towards potentially abandoning the YCC policy.
As the BoJ moves away from strict YCC target limits and embraces a more adaptable stance, the Japanese Yen could witness strengthening trends while traders and investors direct their focus onto the increasing likelihood of the beginning of a new policy direction towards completely exiting the YCC under Ueda. When this rethinking of the timetable of the BoJ normalizing policies picks up momentum, it may leave the path wide open for USDJPY to test the downside.
Latest Market Insights
Quarterly Outlook
-
-
Quarterly Outlook
Equity Outlook: Will lower rates lift all boats in equities?
Peter Garnry
Chief Investment Strategist
After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto... -
Quarterly Outlook
FX Outlook: USD in limbo amid political and policy jitters
Charu Chanana
Chief Investment Strategist
As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ... -
Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c... -
Quarterly Outlook
Commodity Outlook: Gold and silver continue to shine bright
Ole Hansen
Head of Commodity Strategy
-
Quarterly Outlook
FX: Risk-on currencies to surge against havens
Charu Chanana
Chief Investment Strategist
Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo... -
Quarterly Outlook
Equities: Are we blowing bubbles again
Peter Garnry
Chief Investment Strategist
Explore key trends and opportunities in European equities and electrification theme as market dynami... -
Quarterly Outlook
Macro: Sandcastle economics
Peter Garnry
Chief Investment Strategist
Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p... -
Quarterly Outlook
Bonds: What to do until inflation stabilises
Althea Spinozzi
Head of Fixed Income Strategy
Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ... -
Quarterly Outlook
Commodities: Energy and grains in focus as metals pause
Ole Hansen
Head of Commodity Strategy
Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer