Why Investors Must Pay Attention: BOJ’s Hawkish Moves Could Roil Global Markets

3. 10-Year Spread yields likely to rise towards 2%: The BOJ has indicated it can tolerate higher long-end rates as long as real long-term interest rates remain negative, maintaining the effects of monetary easing. As cited in the latest BOJ monetary policy statement “Real interest rates are expected to remain significantly negative after the change in the policy interest rate, and accommodative financial conditions will continue to firmly support economic activity”. This implies that the BOJ isn’t overly concerned about 10-year JGB yields rising further, making a 2% yield a possible target by year-end.

Implication for US Treasuries and European sovereigns.

The continuous unwinding of the carry trade can put US and European bonds under pressure. Investors who borrowed yen at low interest rates to invest in higher-yielding assets, such as U.S. and European bonds, might start selling these foreign assets to cover their positions as Japanese yields become more attractive. This selling pressure can lead to higher yields and lower prices for U.S. Treasuries and European sovereign bonds, increasing borrowing costs and potentially impacting global financial markets.

Already, it doesn’t make sense for Japanese investors to buy foreign securities because, when hedged against the yen, they yield a negative annual return. Even unhedged, investors need a strong dollar or euro. With the ECB having cut rates and the Federal Reserve likely to begin a rate-cutting cycle soon, these currencies are unlikely to appreciate against the yen. As the BOJ remains on a path to hike rates, the attractiveness of foreign securities diminishes further, discouraging Japanese investments abroad.

Such shift in appetite can lead to rising long-term yields globally, igniting a bear steepening of yield curve, which could challenge valuation in stock markets.

Stock markets should be wary of a hawkish Bank of Japan

As the yen strengthens, Japanese investments in U.S. stocks and bonds are losing value, putting markets at risk. The recent decline in U.S. stock prices exacerbates this problem, making these investments less attractive and more unprofitable for yen investors. Repatriation could cause stock markets in the U.S. and Europe to tumble and yield curves to bear-steepen.

Often overlooked, bear-steepening of yield curves can exacerbate the stock market selloff in several ways:

• Increased Borrowing Costs: Higher long-term rates raise borrowing costs for companies, reducing their profitability and ability to finance growth.  
• Discount Rate Impact: Rising yields increase the discount rate used in valuing future cash flows, making stocks less attractive relative to bonds.
• Economic Slowdown Fears: A steepening curve often signals expectations of higher inflation and potential economic tightening, which can reduce investor confidence in equities.
• Sector-Specific Pressures: Interest rate-sensitive sectors like real estate and utilities may suffer due to higher financing costs and lower consumer demand.

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