It was a development that seemed to come out of nowhere on Thursday, nudging 10- and 30-year Treasury yields above 4% and taking the steam out of U.S. stocks despite a round of resilient economic data.
A news report by Nikkei about a likely tweak to the Bank of Japan’s yield-curve control was all it took for investors to realize that the world’s last remaining floor on interest rates might be shifting. The BoJ followed through on Friday, by switching to a more flexible policy that enables the country’s 10-year yield BX:TMBMKJP-10Y to rise above the 0.5% upper cap that’s been in place since December.
In response, 10-year yields across the world moved slightly higher on Friday, with most of them finishing with small weekly advances, according to Tradeweb. Some of the knock-on effects of the BoJ’s decision are likely to include upward pressure on global government-bond yields, an appreciating yen, and less reason to own Treasurys relative to Japanese bonds, said Thomas Mathews, a London-based senior markets economist for Capital Economics.
“The Bank of Japan seems to have effectively ended yield curve control without making a big splash in financial markets” on Friday, “but we wouldn’t rule out further effects — on Japan’s markets and those around the world — just yet,” Matthews wrote in a note.
Yield-curve control, which was enacted in 2016, has been the BoJ’s way of heading off deflation risks and stimulating Japan’s economy by encouraging consumers and businesses to spend and invest. By pinning the yield on 10-year government bonds to around zero, the idea was that the bank would purchase any outstanding bonds at a price consistent with that target on days when private investors were unwilling to do so. Meanwhile, Japanese policy makers have left their short-term policy rate unchanged at minus 0.1% for seven years.
Now that inflation has taken hold around much of the world, including Japan, the BoJ is being forced to loosen its grip on interest rates, suggesting the world’s last dovish bastion is about to go in a more hawkish direction. Though Gov. Kazuo Ueda said Friday’s adjustment doesn’t mean a shift away from the central bank’s easy-money stance, investors aren’t so convinced. For now, the BoJ is relying on its upper 0.5% cap on Japan’s 10-year yield as a suggestion, not a limit, and said it will purchase bonds at a 1% yield every business day, essentially doubling the range in which the long-term rate can move.
“For so long, Japanese government bonds have been totally anchored, acting as a floor for rates worldwide. The BoJ, which is the biggest holder of Japanese government bonds, has kept short-term rates incredibly low while allowing yield-curve control to impact longer-term rates,” said Will Compernolle, a macro strategist at FHN Financial in New York.
Replacing a rigid boundary on Japan’s 10-year yield with a wider range “introduces an ultra-safe asset into global financial markets with slightly higher yields, and suggests there may be a change in policy in a more hawkish direction down the line,” Compernolle said via phone. “The idea that even the BoJ is getting slightly more hawkish really represents a new phase for central banks, and shows that Ueda is not the same as his predecessor.”
Japan is by far the biggest major foreign holder of Treasury securities, owning more than $1 trillion as of May, followed by mainland China and the U.K., based on the most recent data from the U.S. Treasury Department. Mathews of Capital Economics estimates that Japanese residents account for about 15% of the foreign holdings.
A slightly higher yield on Japan’s government debt now makes it incrementally more attractive relative to that of the U.S., analysts said — which is what had U.S. markets so rattled on Thursday. Bond investors sold off Treasurys late Thursday, sending the 10-year U.S. yield to an almost two-week high and the 30-year bond yield to its highest since November. The rise in yields was powerful enough to knock all three major stock indexes
DJIA,
SPX,
COMP,
into lower finishes and put an end to a 13-day winning streak in Dow industrials.
“As the last dovish central bank standing, the developments in Tokyo overnight present yet another piece of information that adds to the increasingly restrictive monetary policy backdrop on a global level,” said BMO Capital Markets strategists Ben Jeffery and Ian Lyngen.
Treasurys “are not the sole flight-to-quality instrument,” they said in a note. And “now one needs to take into account the global backdrop when contemplating where 10s [the 10-year U.S. yield] should trade.”
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