The Bank of Japan’s success in controlling the shape of the bond market’s yield curve could tempt other central banks to consider deploying similar tactics as they grapple with a rise in borrowing costs that could cripple their economies.
The Japanese central bank has kept bond yields largely pinned inside a narrow range around 0%, since it adopted its yield curve control (YCC) policy in 2016.
The merits of the policy are clear. By shifting to targeting yields, the BOJ could buy fewer bonds than under its massive bond-buying programme many analysts saw as unsustainable.
With a pledge to cap the 10-year Japanese government bond (JGB) yield at zero, the BOJ has kept rises in the benchmark yield at just 17 basis points this year, even as the U.S. Treasury yield spiked 70 points.
“YCC is working quite well. It relieved the BOJ from the burden of having to buy bonds at a set pace,” said former BOJ executive Shigenori Shiratsuka, currently professor at Keio University.
“Major central banks will probably follow in the footsteps of the BOJ,” as keeping rates low would be crucial in helping governments manage the huge cost of combating COVID-19, he said.
Indeed, some central banks are warming to YCC as they hunt for ways to reflate growth with dwindling policy ammunition.
Australia’s central bank adopted YCC in 2020 and defended its three-year yield target with huge bond buying.
The European Central Bank does not conduct explicit YCC but is tying its stimulus more heavily to the yield curve.
ECB board member Fabio Panetta said on Tuesday the recent steepening in the yield curve was “unwelcome and must be resisted,” pointing to the merits of a “firm commitment to steering the euro area yield curve.”
“This has to be as far as any ECB official ever went in terms of YCC commitment,” Pictet Wealth Management strategist Frederik Ducrozet said of Panetta’s comments.
Japan’s nearly five years of experience with YCC has exposed some of its flaws. The BOJ has said it will look into making its tools more “sustainable and effective”, including by addressing the demerits, when it carries out a policy review this month.
Indeed, YCC could be difficult to maintain and may not suit everyone. The Fed has stopped short of introducing a yield cap, despite studying it for years.
BOJ policymakers concede YCC worked in Japan because of the central bank’s huge presence in the bond market and a dearth of expectations that inflation would pick up.
On the rare occasion the 10-year yield deviated from its target, the BOJ stepped up purchases such as through a “special” operation where it offered to buy unlimited amounts at a set price.
This could be a costly operation in a vastly diverse $18 trillion US Treasury market, where controlling yields could be far more challenging than in the $9 trillion JGB market.
“I won’t rule out the chance of the Fed adopting a two-year yield cap, if interest rates continue to rise and destabilise the stock market,” said former BOJ official Nobuyasu Atago, who is now chief economist at Japan’s Ichiyoshi Securities. “But there’s a lot of uncertainty on whether it will work.”
For now, major central banks see no problem with higher inflation. Fed policymakers consider the recent jump in yields as an “appropriate” reaction to hopes for higher growth.
Even if the rise were to be considered too much, the Fed has an interim step short of YCC, such as buying longer-dated bonds.
Being too successful with YCC comes at a cost. Market liquidity dried up as Japan’s 10-year yield mostly hugged a 20-basis-point band around the 0% target since YCC was rolled out.
The BOJ will thus discuss ways to allow 10-year yields to deviate more from its target at the March review, sources have told Reuters.
Allowing yields to rise more would help make YCC more sustainable, as vaccine rollouts could drive up economic growth, inflation and long-term rates in the coming months, analysts say.
But if the BOJ allows rates to fluctuate more widely, it risks undermining the credibility of YCC.
“If the BOJ is being forced to allow yields to move at a wider range around its target, it shows that markets are deciding the shape of the yield curve and that there are limits to the BOJ’s ability to control it,” said former BOJ deputy governor Hirohide Yamaguchi.
“It’s hard to control long-term interest rates within a tight range for a long period of time.”—Reuters
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