Japan Prepares To End Quantitative Tightening Amid Bond Market Turmoil
With Japanese bond yields recently hitting record highs and bond market volatility soaring, overnight Reuters floated a trial balloon that Japan's central bank may pause the unwinding of its massive debt holdings next fiscal year, which would give Prime Minister Sanae Takaichi some relief amid growing investor concerns about her growing spending plans.
A pause would mark a turning point in the Bank of Japan's quantitative tightening plan - started in 2024 as part of Governor Kazuo Ueda's efforts to unwind a decade-long, massive stimulus which everyone said would result in failure. Well, there it is. The next step, of course, is more QE.
According to Reuters, which is well known for being the mouthpiece of BOJ insiders, at its June 15-16 meeting, the Japanese central bank will review its bond taper plan running through March next year and lay out a new plan for fiscal 2027. With no change expected to the existing taper plan, markets are focusing on whether the BOJ would keep reducing its monthly bond purchases in fiscal 2027 or maintain the current pace.
While there is no consensus yet within the BOJ on the final decision, a pause in taper is increasingly seen as the preferred option with uncertainty over the Iran war keeping bond markets jittery, said two sources familiar with the deliberations.
"Markets remain volatile, so there's no need to rush," one of them said on the BOJ's taper, adding that many market players appeared to favor maintaining the current pace of buying. Ironically, the market volatility is precisely the reason to rush.
Political considerations may also push the BOJ to pause as rising bond yields threaten to confine Takaichi's spending plans. "What the administration wants to avoid most is rises in bond yields," said one of the sources. Of course, if the intention is to avoid bond yields from surging, it's far too late.
Japan's 20Y bond yield rises as high as 3.511%, highest since 1996 as global interest rates go vertical pic.twitter.com/Rc1gKjfGyo
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Confirming the end of the QT is effectively a done deal, some investors are now calling on the BOJ to pause its bond taper plan, a central bank survey earlier this month showed, highlighting the challenge it faces in reducing its massive Japanese government bonds (JGB) holdings.
Even before the Reuters report, there had already been some indications the BOJ might consider slowing its taper plan amid market uncertainty. A clearer signal on the BOJ's taper plan will come next week, when the central bank releases minutes of its meeting with bond market participants held on May 21-22.
"We've seen a pretty fast rise in bond yields, which makes it hard for investors to buy bonds. The finance ministry may be getting worried too," said former BOJ official Nobuyasu Atago. "Given the political headwinds, I see no reason for the BOJ to keep tapering next fiscal year," he said.
Concerns over Japan's worsening finances and rising inflation pushed up the 10-year JGB yield to a 30-year high of 2.8% last week, nearing the 3% estimate the finance ministry set in compiling its fiscal 2026 budget. A rise above 3% would boost debt servicing costs and reduce scope for other spending.
The BOJ's rate-hike decision may also affect its taper plan with an increase in short-term rates to 1% from 0.75% seen as a strong possibility at the June meeting. While the central bank has said its taper program has no monetary policy implications, the case for slowing QT becomes stronger if it pushes through a hike, something it has been woefully unable to do so far despite a collapsing yen.
"With the bond market so unstable, it would be natural for the BOJ to play it safe and avoid causing undue market turbulence," said Mari Iwashita, executive rates strategist at Nomura Securities, who projects a taper pause in fiscal 2027.
"A combination of a taper pause and rate hike would be a good one," as the former will ease upward pressure on yields, while the latter would alleviate concern the BOJ is behind the curve in addressing inflationary risks, she said.
It's not just Japan: rising debt and volatile yields have heightened challenges for central banks unwinding their balance sheets that ballooned from years of heavy asset purchases to reflate their economies. In the US, analysts doubt whether new Fed chief Kevin Warsh can push through his calls for a smaller balance sheet as U.S. Treasuries lose their luster.
The BOJ has also been cautious in its QT program which started in 2024, and under which the central bank gradually reduced purchases and currently trims monthly buying by 200 billion yen each quarter.
Political hurdles for the BOJ's QT have heightened under Takaichi, who has vowed to cut tax and boost spending by issuing even more debt in the world's most indebted economy.
Taper or not, a reduction in the BOJ's holdings, currently at around 500 trillion yen, will proceed steadily due to the runoff of maturing JGBs that already shaved 20% off its balance sheet from a peak in late 2023.
That's all the more reason for the BOJ to maintain the current pace of buying, said former BOJ executive Akira Otani, currently at Goldman Sachs Japan.
"When inflationary risks from the Middle East conflict and the government's proactive fiscal policy are putting upward pressure on bond yields, proceeding with further tapering could cause political friction by pushing up yields," he said.