The Bank of Japan is Tightening
October 2, 2024
When someone tells you something is wrong, they’re probably right. When they tell you how to fix it, they’re probably wrong.
Recently there has been a lot of attention on the relatively weak Japanese Yen, few deny this is a problem for Japanese savers, consumers, and thus politicians.
The range of remedies prescribed by politicians, bureaucrats, papers and pundits, is endless and often contradictory. We’ve seen the MOF intervene with billions of reserves.1 The woman who was nearly elected PM says a weak Yen isn’t a problem.2 The new PM, Ishiba, has both expressed support for strengthening the Yen, and weakening it.
More interesting than the miracle cure – which doesn’t exist because their is no objective best Yen strength – is exploring the variables driving Yen strength/ weakness.
The Bank of Japan (BOJ) has a large role in managing the Yen because it controls interest rates. In fact, it has been the most hands on central bank in the world over the past ten years when it comes to controlling interest rates and bond yields. The BOJ has pioneered numerous policies to guide the Yen and government bond (JGB) markets. Quantitative easing (QE), yield curve control (YCC), and negative interest rate policy (NIRP) are big ones.
NIRP is over and considered a failed experiment by most, though I’m sure it will be tried again somewhere.
QE has become globally accepted as the ‘correct’ policy response to deflation or bank stress.
YCC while generally frowned upon by the public and most academics, has not been condemned by central bankers, and is what I’ll focus on today.
There is no single YCC policy. If a central bank creates a mechanism, mandate, incentive, or trading desk to buy bonds in order to control yields, it is engaged in YCC. The more vigilant they are about keeping yields at a certain level, the more blatant the YCC is.
The BOJ has practiced strict YCC since 2016. Interestingly, it started as a floor, though it quickly became a ceiling.3 The bank buys JGBs on a set schedule and reserves the right to buy, unannounced, an unlimited amount of bonds. By paying a higher price than the market would, the BOJ has been able to artificially suppress yields for almost a decade.
Unsurprisingly, they now own a whole lot of JGBs.
Around two years ago I started working on a project to track the BOJ’s purchases of JGBs. The bank had just started loosening their grip on the 10-year JGB (JP10Y) market, and engaged in an absolutely massive open market operation to keep the market from rapidly selling off in response. The first chart shows how JP10Y yields reacted to the policy change, and following open market operation. The second chart shows the change in BOJ holdings of the JP10Ys since the previous report – the spike on the left is their January ’23 buying operation, to the tune of 10 trillion Yen in 10 days.
As I’ve started to more regularly analyze the BOJ reports on JGB holdings, it has become clear this year is an outlier during the YCC era. The bank is allowing more JGBs to roll off their balance sheet than they are adding. The net flow of JP10Ys is negative. I am reading this as the BOJ engaging in stealth quantitative tightening (QT).
My understanding of QT is a reduction in the bonds held by a central bank, which is what the BOJ is doing. It is a misconception that QT requires selling of bonds.
In 2024 the BOJ has had three JP10Y CUSIPs roll off the balance sheet (#333, #334, #335), totaling 21 trillion Yen. Using the regularly released JGB holding reports, these roll offs can be visualized by charting the net change in holdings since the previous report.
The roll offs are also visible when charting the BOJ’s total JGB holdings by report for 2024. So far in 2024 the BOJ holdings of JP10Ys is down 7.78 trillion Yen.
Contrast these 2024 charts with the corresponding ones below showing a ten year timeframe. Apologies for the illegible x-axis labels, I’m still learning.
2024 has been quite different from the previous nine years, which exhibited a rapid balance sheet expansion of JP10Y holdings.
The BOJ has engaged in nearly a decade of QE and YCC, until now. This shift has largely gone unnoticed (at least by the retail catering commentators I have access to). Much has been made about lifting the JP10Y YCC bands, raising the policy rate, and planned reduction in scheduled JGB purchases – not so much the JGB holding reductions.
Making the situation even more interesting, is the current JP10Y yield, sitting well below 1% as of writing on October 2nd. Benchmark yield well under the upper YCC band with limited buying = huge win for BOJ credibility, let’s see how long it lasts.
I will admit, the timing of this piece is cherry picked. I knew there would be a JP10Y roll off in September, which would put the BOJ net negative on the year. I should add, the BOJ holdings of ALL JGBs is flat to slightly positive on the year as of writing. This suggests the BOJ is focusing its limited buying on other areas of the yield curve than the 10-year, an interesting development that warrants its own piece. Its just good PR. Even if the BOJ ends the year slightly net positive in JGB holdings from where it started, that is still a notable shift from past years!
In conclusion, while the Yen continues to draw attention, behind the scenes the BOJ is engaged in stealth QT. Perhaps they would like JP10Y rates higher, as that would strengthen the Yen?
Regardless, my goal is not to point out problems or suggest solutions, merely to note a change in BOJ behavior as I continue to follow their actions in the JGB market.
Coming soon: a more detailed exploration of the BOJ’s annual JP10Y purchases since 2014.
- https://www.cnbc.com/2024/07/31/japan-confirms-36point8-billion-yen-intervention-as-boj-hikes-rates.html
https://www.reuters.com/markets/currencies/investors-foxed-by-japans-revamped-fx-intervention-blueprint-2024-07-24/
https://www.google.com/search?q=japanese+yentervention+headline&rlz=1C1RXQR_enUS1124US1124&oq=japanese+yentervention+headline&gs_lcrp=EgZjaHJvbWUyBggAEEUYOTIJCAEQIRgKGKABMgkIAhAhGAoYoAEyCQgDECEYChigATIJCAQQIRgKGKAB0gEINDM0OWowajeoAgCwAgA&sourceid=chrome&ie=UTF-8 ↩︎ - “Some say a weak yen is terrible, but the merit of a weak yen is great.” https://finance.yahoo.com/news/boj-watchers-focus-ldp-election-131129662.html ↩︎
- https://libertystreeteconomics.newyorkfed.org/2020/06/japans-experience-with-yield-curve-control/
↩︎
Leave a Reply
You must be logged in to post a comment.