The hysteria surrounding the Bank of Japan’s decision (released on 19 December 2022) to fine-tune its cap on the yield curve control on Japan’s 10-year government bonds was predictable, but uninformed and full of vested interest agendas. You know the type of agenda that investment bankers are involved in, they keep making their media statements that get absorbed by the financial media as if they were knowledge that needs to be repeated, claiming that interest rates have to go up to deal with some inflationary emergency or something. What the media doesn’t tell the public that absorbs this stuff, is that the real agenda is that the bankers want higher rates because they make more profits, and the reasons given by the media statements are largely fictional. So we’ve seen more of that in the past few days. My understanding of the decision is that it does not represent a fundamental change in Japan’s monetary policy. Adjusting the interface between the government bond market and the corporate bond market is a small shift in order to maintain financial stability – the most important role of the central bank. All those figures who claim that hedge funds have won and that the Bank of Japan is now ceding power to them by raising rates are not reading room. They are only advancing their self-interest in vain. Interest rates are not going up and what I read the statement and what I learned informally through contact is that the bank is committed to its current policy stance because it believes, like me, that inflationary pressures are temporary and doesn’t want to respond by creating a more Deep-rooted real economic recession and rising unemployment to solve a short-lived problem.
The Internet produced these headlines in my news feed this morning.
The frame, the words, all point to the impending disaster.
In fact, it is unnecessary.
what the bank of japan just did
On December 20, 2022, the Bank of Japan issued this statement – monetary policy statement – Announce:
…the Bank of Japan decided to modify the behavior of yield curve control to improve market functioning and encourage a smoother overall yield curve formation while maintaining accommodative financial conditions.
The last sentence tells us the direction of monetary policy – “maintain accommodative financial conditions”.
The World Bank decides:
1. “The bank will implement a negative interest rate of -0.1% on the policy interest rate balance of the current account of the financial institution held in the bank” – this is a statement of principle.
No rate change was announced.
2. “The central bank will purchase the necessary amount of Japanese government bonds, with no upper limit, to keep the yield of 10-year Japanese government bonds near zero” – not restricting the continuous purchase of Japanese government bonds in the secondary bond market to maintain the yield of 10-year bonds rate is close to zero.
In other words, aside from increasing monthly bond purchases by about 20%, its bond-buying program is unchanged.
It is prepared to use its unlimited financial power as a yen issuer to buy as many bonds as possible to maintain its target range for bond yields.
3. The third part of the announcement slightly changes the existing policy:
While significantly ramping up JGB purchases…the bank will widen the 10-year JGB yield’s volatility range from its target level: from about plus or minus 0.25 percentage point to about plus or minus 0.5 percentage point.
The bank will buy 10-year JGBs at 0.5% each business day through a fixed-rate purchase operation, unless there is a high probability that there will be no bids. In order to encourage the formation of a yield curve consistent with the aforementioned market operation guidelines, the central bank will respond flexibly to each tenor by further increasing JGB purchases and conducting fixed-rate purchase operations.
This is change.
The cap on 10-year JGBs controlled by the central bank will rise from 0.25 percentage point to 0.5 percentage point, the new yield the central bank will offer.
Remember that government bond yields and prices are inversely related, and by bidding on prices, banks can control the resulting yields.
Very simple.
Central banks can do this whenever they want, and they can keep yields at whatever target they like, regardless of what bond market investors think is best for them.
The bank also said it would continue to buy non-government financial assets (e.g., exchange-traded funds, real estate trusts) and corporate bonds at pre-pandemic rates.
Response from the financial media
The reaction in the financial media has been exaggerated, to say the least.
The Economist claims it “may herald a period of tightening”, although the bank’s statement made it clear otherwise.
The Economist said 10-year bond yields “surgered” after the announcement – a modest rise to 0.4% from 0.25% in line with the policy change.
It also claimed that the policy shift “removes the BOJ from spending months on bond purchases to enforce the old cap, and that it would take larger losses on its larger bond portfolio.”
Bank officials simply don’t care about any “paper” losses on their balance sheets as interest rate changes affect the sale price of bonds they previously bought.
All the current global discussion about central banks taking losses completely ignores the fact that they are not commercial banks and can operate with negative capital forever.
The Economist quoted one investor as saying it was the beginning of “freedom to act,” code for investors to regain control and make profits at the expense of the Japanese people.
Banks will not allow this to happen, even if that is the hope of the money markets.
So what is this about?
There are a huge number of financial assets – government and non-government – that are traded every day.
They range in maturity from ultra-short to ultra-long, with 10-year bonds near the longer end of the range of maturities available.
Together, government bond assets are known as the “yield curve,” which is basically just a graph of current yields from very short-term to longer maturities.
Along the curve, yields on non-government financial assets such as corporate bonds and Japanese REITs are influenced by conditions in the government bond market.
After all, this is the main goal of quantitative easing – to influence government bond yields of a given maturity and then allow “the market” to adjust the yields of other non-government financial assets to be in line with the controlled government bond yields.
By increasing secondary bond market demand for a particular government bond maturity, central banks push up the trading price of that asset and drive down yields.
It can control the yield at any level it chooses by varying the size of its purchases.
In doing so, it forces yields down on other non-government bonds and the like, which is the goal.
Central banks hope that lower interest rates on the “investment” end of the yield curve – that is, long-term rates – will stimulate borrowing for capital formation in productive capacity (that is, investment), which will help stimulate the economy.
Quantitative easing is not about “giving” more cash or liquidity to banks etc.
It aims to hold down long-term interest rates in hopes of stimulating private investment spending on productive capacity.
The problem with it is that when an economy is flagging, no one wants to borrow money, even if borrowing rates drop sharply.
Back to the story here – the Bank of Japan noted in its Monetary Policy Statement that it is concerned that business firms may find it more difficult to finance themselves through the issuance of corporate bonds.
It also noted that in recent months it had observed “increased volatility in overseas financial and capital markets… [which] … had a significant impact on these markets in Japan”.
with:
The functioning of the bond market has deteriorated, particularly with regard to the relative relationship between interest rates on bonds of different maturities and the arbitrage relationship between the spot and futures markets. The Japanese Government Bond (JGB) yield is a reference rate for corporate bond yields, bank lending rates and other financing rates. If these market conditions persist, this could have a negative impact on the company’s financial conditions, including the issuance conditions of its bonds.
This is the point of understanding change.
Trading volumes of some government bonds of various maturities have been low over time, which has also affected the ability of Japanese companies to issue corporate bonds at reasonable rates.
By allowing the 10-year JGB rate to reach a new, slightly higher ceiling, the BOJ hopes that relations along the yield curve will improve and Japanese companies will find more favorable conditions to issue their own bonds.
That’s really all there is to it.
The bank is not reacting to any increased threat of inflation – it still sees current events as temporary and will dissipate soon.
It’s just a technical tweak aimed at improving conditions for buying and selling in the bond market.
Meanwhile, the Japanese government is about to implement a fuel and utility subsidy program in January, a fiscal policy move that will significantly reduce cost-of-living pressures on Japanese households.
Definitely a different country.
in conclusion
Everyone should have just read the last paragraph that Banks pointed out:
For now, while closely monitoring the impact of COVID-19, the central bank will support financing, primarily for businesses, and maintain financial market stability, and will not hesitate to take additional easing measures if necessary; it also anticipates both short- and long-term policy Interest rates will remain at current levels or lower.
This tells you that despite the hopes of greedy private market players, the banks are not panicking and are not ready to pull the trigger on “freedom to act”.
Restoring calm.
Enough for today!
(c) Copyright 2022 William Mitchell. all rights reserved.
