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Politics

Yield curve proves hard to steer for nervous BOJ

Bond market struggles to discern central bank's signals

While a let-up in Donald Trump's accusations of currency manipulation may have been a relief, BOJ Gov. Haruhiko Kuroda still faces a tough road ahead.

TOKYO -- The Bank of Japan is straining to bend an unruly yield curve to its policy goal, sowing doubts among bond market participants that could make for more trouble ahead.

Thankfully for an anxious BOJ, U.S. President Donald Trump did not raise the subject of the yen at his summit with Japanese Prime Minister Shinzo Abe earlier this month. Stung by criticism that Japan deliberately uses monetary easing to weaken its currency, the central bank had feared such a confrontation.

Behind the curve?

Yet the past month has proven volatile enough in the domestic bond market. The 10-year Japanese government bond yield went for a wild ride Feb. 3 after the BOJ kept its bond buying at the same level as the previous round, despite mounting upward pressure on yields from rising U.S. interest rates. The upswing in U.S. yields in turn owes to Trump's bold proposals for infrastructure spending and tax cuts.

Market participants had expected a major escalation in JGB purchases from the BOJ to maintain its goal of a 10-year yield of around zero. When that did not happen, the yield shot up to 0.150%.

A wrong-footed BOJ then rushed to contain the spike with a round of unlimited JGB buying at an above-market price. The 10-year yield settled down, briefly dropping below 0.1%. But the market was left with the impression that the central bank was reacting rather than in control -- and a lingering feeling of skepticism.

In fact, doubts about the BOJ's bond buying under its new policy of yield curve control had already been sown. In late January, the bank surprised the market by lowering its purchases, leading to speculation that it intended to taper them with a view to winding down monetary easing eventually. Faced with this uncertainty, institutional buyers began moving to the sidelines en masse in February.

The BOJ failed to appreciate the strength of this sentiment, creating a gap that let volatility erupt. One could argue that the turmoil was an inevitable consequence of a complex -- some would say contradictory -- set of monetary policy goals. The BOJ is trying both to maintain the stimulative effects of low interest rates with a negative-rate policy while driving up ultralong-term yields out of deference to insurers, pension funds and other long-haul investors.

The 10-year yield has been calm of late. But it may take little for the mistrust to flare up as another bout of volatility. There is a growing risk that domestic banks and institutional buyers, hard-pressed for attractively yielding assets, overreact to even minor signals in their pursuit of returns.

This raises a troubling question: Having already deployed perhaps its ultimate weapon -- the unlimited purchasing operation -- does the BOJ have anything in reserve to quell a new outbreak of instability?

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