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A woman walks in front of a cheap izakaya in Tokyo, Japan, on March 24. The BOJ cannot keep bond yields low and stop the currency from depreciating at the same time. Allowing the currency to weaken will inflate the problem away, and Japan wants inflation anyway. Photo: Reuters
Opinion
Macroscope
by Clive Ponsonby
Macroscope
by Clive Ponsonby

Banking crisis gives Bank of Japan a chance to gently raise bond rates

  • Japan needs to wind up its expensive bond-buying programme and a weakened currency is the easiest way to inflate the problem away
  • Expect a managed rise in the dollar-yen rate, with the 10-year bond yield likely to rise to 1 per cent by mid-2025
Clive Ponsonby
Clive Ponsonby
Why you can trust SCMP

Earlier this month, Kazuo Ueda was formally approved by the Diet as the new governor of the Bank of Japan to take over after a decade of Haruhiko Kuroda at the helm and almost 20 years of zero interest rates.

The BOJ has also been keeping the 10-year government bond yield near zero, only allowing a controlled rise to 0.5 per cent last December. In defending this cap and committing to bond-buying, the central bank now holds more than half of all government bonds – which has led to the market betting against them.

In a statistical anomaly, it actually owns more than 100 per cent of some 10-year bonds: buying the same bond twice, as some of the securities it lends get sold back. With few natural bond buyers at these low yields, the government is running a huge deficit.

Rising yields elsewhere adds pressure but the government cannot afford to let 10-year yields rise too high when debt servicing is already over 30 per cent of government receipts. If yields were to rise to 2 per cent for a few years, debt servicing would be over 50 per cent, with a massive mark-to-market loss on the BOJ’s balance sheet.

The situation is also affecting the currency, with the dollar-yen rate weakening from 115 a year ago to over 150 last October. When the BOJ eventually intervened last December, allowing bond yields to rise to 0.5 per cent, it got lucky as global yields topped out around the same time.

But it is impossible to keep yields low and stop the currency from depreciating at the same time – the BOJ will have to choose.

Outgoing BOJ governor Haruhiko Kuroda at a council meeting at business lobby Keidanren (Japan Business Federation) in Tokyo on December 26. Kuroda stressed that the latest tweaks on its bond yield control programme were not the beginning of an exit of monetary easing, but a way to make it sustainable and run smoothly. Photo: Bloomberg
With Japan’s debt-to-gross domestic product ratio at over 260 per cent and increasing, and given an ageing population, it will be difficult for the BOJ to maintain its long-held policy.
It got away with it for so long because other central banks copied its zero interest rate policy. But even the European Central Bank is hawkish this time, and at the start of the year, bond yields around the world rose beyond the highs seen last October – before falling back on news of Signature Bank, Silicon Valley Bank and Credit Suisse imploding. This leaves the government and the BOJ with three options.

Option one would be to default, which would transfer the problem to Japanese citizens and not solve anything.

The second option would be to inflate the problem away by letting the currency depreciate. Seeing as inflation is a slow-burn version of default, eroding purchasing power over time, the BOJ will have to carefully manage the rise in bond yields. Already, amid speculation that the BOJ will abandon its so-called yield curve control policy, 10-year swap yields have risen by half a percentage point higher than bonds at times.

The third option is to hope for a global recession to reverse the direction of global interest rates. If the US Federal Reserve starts cutting rates before the first quarter of next year, the BOJ could perhaps buy a few more years. But with new-normal rates expected to be above 2 per cent, this is wishful thinking.
The yen-dollar exchange rate is displayed on the monitors of a foreign exchanging trading company in Tokyo, Japan, on October 21 last year. The yen hit a 32-year low last October, remaining in the 150 range. Photo: EPA-EFE

The BOJ finds itself in the third position, and recent events mean it may get its wish in the short term, but is likely to have to pivot to position two at some point this year. A weakened currency is the easiest way to inflate the problem away, and Japan wants inflation anyway. It could be seen as a successful outcome for the BOJ to have finally managed it after decades.

It would probably be a managed rise in the dollar-yen rate, as we have seen with the dollar-yuan rate, although this is much easier for the People’s Bank of China to control. The red line for the dollar-yen rate was widely seen as 150 last October, with an aggressive push from 145 to 140 in November.

New BOJ governor’s No 1 challenge? Ensure its policy benefits the people

For incoming BOJ governor Ueda to immediately change policy would be seen as disrespectful to Kuroda. This was why the outgoing governor raised bond yields last December, allowing his successor to continue to do so. Still, we should expect no changes for Ueda’s first two meetings.

A more likely scenario would be to raise the bond yield to 0.75 per cent and then 1 per cent over the second quarter next year and the first half of 2025.

Incoming BOJ Governor Kazuo Ueda attends a hearing session at the upper house of the parliament in Tokyo, Japan, on February 27. Photo: Reuters

A move that’s too fast could put a lot of downward pressure on bonds. It is an outside possibility that with the latest banking crisis and lower bond yields, there is a chance for the BOJ to change its bond policy when there isn’t immediate pressure on the upper edge of the band – but that would require it to act fast.

In the next few months, the currency is likely to take the strain, and it may be that more investors will go long on the dollar-yen pair, for good reasons. US bond yields could cause some volatility initially, but with US interest rates rising again this month, there seems to be a sufficient risk-reward balance for this.

The euro-yen pair is also a good way to take out some dollar volatility, with the European Central Bank still behind the curve. While the Fed is much closer to the terminal rate (the longer-term target rate of stability), the European Union economy is less robust.

Clive Ponsonby is the author of the Hedder monthly series “Currency View” and the Currency Fellow at Hedder

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