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Capital Markets

Market sees hints of normalization in BOJ's tapered bond-buying

Yen and yields spike after central bank cuts long-dated JGB purchases

The Japanese central bank's decision to cut JGB purchases has roiled global currency markets since Jan. 9.   © Reuters

TOKYO -- The Bank of Japan's decision to cut back on long-dated Japanese government bond purchases is stoking nervous chatter among market-watchers that the central bank is preparing to tighten its extremely loose monetary policy.

On Tuesday, the BOJ said it will reduce its purchase offers for JGBs with 10 to 25 years until maturity as well as those with 25 to 40 years left by 10 billion yen ($89.7 million) each. It was the first time in more than a year the bank curtailed a purchasing operation of bonds with 10 to 25 years left to maturity.

At around 10:10 a.m. Tuesday, right after the notice came out, the yen began a sharp advance in the Tokyo market, strengthening by approximately 0.50 yen against the dollar in just 30 minutes. The currency eventually appreciated from just over 113 yen that morning to 111 yen and change on Wednesday.

Japanese long-term yields also bounced to two-and-a-half month highs, which put upward pressure on U.S. long rates as well.

"The speculation that the BOJ will adjust its policy is the cause," said Osamu Takashima at Citigroup Global Markets Japan.

BOJ officials, however, dispute that conjecture. "The daily market operations contain absolutely no intent to shift policy," said a source from the central bank.

The BOJ has engaged in so-called "stealth tapering" of JGB purchases ever since it shifted its focus from the monetary base to rate controls in September 2016. JGB holdings used to rise by an 80 trillion yen annual clip, but now the pace has slowed to the 50-trillion-yen range.

"The market radar has picked up on the stealth," said Daisuke Karakama at Mizuho Bank.

Bank of Japan Gov. Haruhiko Kuroda

Since fall last year, BOJ Gov. Haruhiko Kuroda and others have broached the subject of the "reversal rate," or the level at which excessively low interest rates start to hurt the financial system and cause the effects of monetary easing to reverse.

The market has taken notice of those remarks, especially within the current economic climate. Inflation has recently climbed to 0.9%, though it still far short of the 2% stability target. The Japanese economy is currently in its second-longest sustained expansion in the postwar era.

In this context, an increasing number of market players are anticipating that the BOJ will raise its target level for guiding long-term yields from the current threshold of around 0%. Hiroshi Ugai of J.P. Morgan predicts hikes of 0.25 percentage point in September and December.

Nobuyasu Atago at Okasan Securities also sees something like a rate hike in the near future. "It is very possible that [the BOJ] will place the guidance target at around 0.2% in the middle of the year," said Atago.

Out of 39 economists surveyed by the Japan Center for Economic Research in December, 15 predicted that the rate control level will be lifted sometime this year.

Even some within the BOJ wish to lift interest rates. For one, a slight calibration of long-term yields will not greatly dampen the positive easing effects. And such a move would create wiggle room to act against any future economic setback.

However, a hard yen could throw cold water on reflationary efforts. And if the BOJ unintentionally signals that it is tightening its monetary policy, investor reaction might strengthen the yen beyond expectations and drive interest rates higher. While central banks in the West are moving to normalize their easy-money policies, the BOJ risks spending another year in the straitjacket. 

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