Dammit no one is really talking about this, but it’s definitely notable.
On both Monday and Tuesday we said that Japan has set its sights on JGB 5Y yields. Basically, the 5Y has become the new frontier in capping 10Y yields.
“It looks like the BoJ may now have to fight to contain 5Y JGB yields, which speaks to the notion that you can’t just cap one maturity when that maturity is itself influenced by other factors,” we wrote first thing Monday morning.
“BOJ battleground for capping yields could be shifting to 2- and 5-year bonds as rising yields for the maturities helped push up those on 10-year securities last week,” Satoshi Shimamura, head of rates and markets for the investment strategy department at MassMutual Life Insurance said earlier this week, adding that “as foreign demand for medium-maturity JGBs shrinks, the 5-year yield climbs above -0.04% level where BOJ held fixed-rate operation in November.” Here’s a look at a 1-month for the 5Y:
Well on Tuesday there was good news on that front as a five-year JGB auction drew a bid-to-cover of 4.85, the highest since August 2014, and up from 4.71 at previous offering on June 8.
“The results of the five-year auction was good, but yields in general remain in an uptrend,” Akio Kato, general manager of Mitsubishi UFJ Kokusai Asset Management’s trading section noted, adding that “the BOJ is expected to stay alert as underlying market sentiment for JGBs remains bearish.”
Fast forward to Wednesday and sure enough, the BoJ increased outright purchases of government notes for 3-to-5 year maturities at its regular operation in an effort to put a lid on medium-term yields. Here are the details from Bloomberg:
- BOJ raises purchase volume of 3-to-5 year notes to 330b yen from 300b yen offered at previous operation on July 5
- This compares with the July plan to spend about 250b to 350b yen at the 3-to-5 year operation
So basically, YCC now includes the 5Y. Here’s a 3-day chart:
“The Bank of Japan’s action wasn’t predicted by the consensus, so markets took it positively with bond futures rising,” Naoya Oshikubo, a rates strategist at Barclays noted, adding that Kuroda “showed [his] commitment to contain any upward pressure in the 10-year yield by capping the five-year.”
10Y yields fell, hitting their lowest since the BoJ moved in last week after yields pushed above 0.10% for the first time since mid-February.
Just to be clear, this is important. Because as the Fed moves not normalize and as other DM central banks follow, Japan is going to be the last man standing. It’s going to get more and more difficult to defend YCC if other DM yields rise.
Eventually, they could be forced to raise the 10Y cap lest the yen should get unpalatably weak. Recall what Citi said on Tuesday:
The risk [is] that the US QE unwind could be followed in 2018 by ECB tapering and [that could] possibly [lead] to a higher JGB yield target as relative policy divergence triggers JPY weakness.
But that’s not a worry for Wednesday, because the yen is bid on safe haven flows thanks to Donald Trump Jr. snitching on himself via Twitter and also thanks to dovish comments from Lael Brainard.
“It’s yen strengthening, with Brainard’s comments yesterday raising wariness about the pace of Fed rate hikes this year ahead of Yellen, while the issue of Trump’s son is also prompting people to take profits on the dollar,” Kengo Suzuki, chief FX strategist at Mizuho Securities said this morning.
Of course that could all change with Yellen’s testimony – we’ll see.
But again, the most notable news from Japan is the “mission creep” on YCC and for now, it’s “mission” accomplished. “I don’t expect BOJ to take further action today as what it did is almost perfect,” the above-mentioned Naoya Oshikubo concludes.
Watch this going forward as this is increasingly becoming “Kuroda vs. the world.”