What If The Bank Of Japan Is About To Shock The Market & Suddenly Drop Yield Curve Control?
A Massively Underappreciated Risk
Note: Normally, the weekly macro observation piece gets published on Friday. Given how I wanted to talk about the Bank of Japan’s current thinking and the fact that it will be announcing its latest policy decision overnight tonight, I wanted to publish my thoughts before it’s announced and the market has a chance to react. I’ll resume the normal publishing schedule next week. Enjoy (and buckle up)!
This has been a big week for global central banks. The Fed raised its benchmark rate by another quarter-point to a 22-year high of 5.25%. The ECB did the same and indicated that it probably isn’t done yet. The Bank of England and the Reserve Bank of Australia are expected to do the same next week.
One central bank that continues to hold out is the Bank of Japan. It hasn’t raised its key short-term interest rate since all the way back in early 2007 and has kept it at 0% or below since 2010. After years of stagnant growth and low inflation to deflation, the BoJ added yield curve control in 2016. This was designed to keep pumping money into the economy to bring inflation up to its 2% target and stimulate long sought after growth in the process.
The process largely hasn’t worked. What’s happened is that the Bank of Japan now owns a big chunk of the country’s bond market and yields have been suppressed to the point where Japanese government bonds are no longer enticing to investors. Every time bond yields have risen to compensate for this lack of demand, the BoJ has stepped in to knock them right back down. In 2018, the BoJ expanded the target yield range on the 10-year bond to +/-0.1%. In 2018, it was widened to +/-0.25% and again to +/-0.50% last December. Pressures on the country’s bond market have eased, but growth and inflation have remained elusive.
Until recently, that is. The latest data suggests that Japan might finally be starting to see the growth and inflation it had been hoping for. But with that comes the potentially difficult decision on how to adjust monetary policy appropriately to keep momentum on the right track.
The Case For Tightening Now Is Growing
If the Bank of Japan wants to make a data-driven decision on what to do with policy, they could easily make the case that tightening is warranted now. The question is whether it thinks there’s enough evidence and whether it’s sustainable before actually pulling the trigger.
Let’s look at three major data points that central banks consider when deciding how to adjust policy.
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