Japanese Bond Yields Surge, Yen Spikes As Kuroda Disappoints Market: "The Market Will Test The BOJ"

One week ago, yields on the Japanese 10Y JGB tumbled when the BOJ relented, and succumbed to market demands to expand its debt monetization, when it increased the size of its daily bond purchase operation, or POMO in NY Fed parlance, in the 5-10 year zone from JPY410BN to JPY450BN, which sent yields tumbling as market participants assumed the BOJ would chase every uptick in yields with progressively greater bond purchases. The day before, on January 25, the BOJ upset market expectations as it held off on the purchase of JGBs with maturities of more 1-3 three years and 3-5 years. Two days later, however, it increased the purchase of JGBs with maturities in the 5-10 year zone by 40 billion yen from the previously known amount, to 450 billion yen.

The unexpected moves aroused speculation as to whether the BOJ is preparing to taper its quantitative easing program. With market participants split in their views on the BOJ's stance on monetary easing, yields on JGBs fluctuated wildly.

Fast forward to Friday, when on the previous day the 10Y JGB blew out to 0.10%, the highest yield since the JGB unviled NIRP one year ago, and prompted a fresh round of speculation whether the BOJ would again increase the amount of debt it purchased.  It did not, and as a result Japan’s 10-year yield surged as traders judged the central bank’s expanded bond purchases Friday to be insufficient to cap borrowing costs as global rates continued rising and steepening around the globe.

The 10Y yield rose as much as 4 bps to 0.15%, the highest since January of 2016, while the yield on the 20-year bond also climbed three basis points to 0.720%.

What is surprising is that the BOJ did increase purchases for bonds due in 5-to-10 years to 450 billion yen ($4 billion), from 410 billion yen planned for the first operation this month. However, since 450 billion is what the BOJ did last week when 10Y yields were lower, the market was clearly hoping for even more.  Furthermore, instead of purchasing bonds in the longer duration 10Y+ bucket, the central bank instead picked shorter maturities at 1Y, hinting there may be a scarcity in long-dated supply, arguably the stuff of Kuroda's nightmares.

The increased purchase in the 5-10Y bucket mirrors the scale from last week, with the BOJ so far refraining from repeating its November offer to buy an unlimited amount of bonds at a fixed rate. The central bank has the option to announce fixed-rate operations at 2 p.m. Tokyo time Friday.

“There were some expectations that given the level of the yield rise, the amount would be boosted more,” said Souichi Takeyama, a rates strategist at SMBC Nikko Securities Inc. in Tokyo. “The focus will be on whether the BOJ will deliver further action later in the day as it still has options to rein in the rise in yields.”

A second analyst echoed the sentiment: “It’s not enough,” said Simon Pianfetti, a senior manager in the market solutions department at SMBC Trust Bank Ltd. in Tokyo and added that “the market will test the BOJ further.”

As Bloomberg adds, BOJ Governor Haruhiko Kuroda faces the challenge of seeking to hold down borrowing costs just as accelerating inflation is pushing up bond yields globally. While Kuroda on Tuesday recommitted to his yield-curve control strategy to hold 10-year debt at around zero percent, he also said investors shouldn’t pay too much attention to daily operations, reinforcing earlier efforts to expand the central bank’s flexibility in purchases.

As a reminder, the BOJ has committed to "curve control", meaning it needs to adjust its bond purchases to account for any divergence in the 10Y away from 0%, which means the higher the yield, the more the BOJ needs to purchase. Which is why on days like today, when the BOJ disappoints, the reaction can be so violent, and not only in bonds, but also in the Yen, which jumped by 40 pips since the BOJ's disappointing announcement, and the USDJPY sliding from 112.95 to 112.55.

“Market looks to have been looking for a broader spectrum of purchase increases to reaffirm the commitment,” said Peter Dragicevich, a foreign-exchange strategist at Nomura Holdings Inc. in Singapore. “But as the BOJ minutes noted this morning, some members have called for flexibility in meeting the target.”

Analysts interpret the BOJ’s target of around zero percent to mean a range between positive and negative 0.1 percent. Still, a few BOJ board members at the December policy meeting said the central bank should avoid setting a uniform range for its management of bond yields, minutes of that gathering showed Friday. With the 10Y blowing out beyond that key level, any failure by the BOJ to respond with an expanded monetization on Monday could result in a yield blow out.

And sure enough, with the BOJ leaving markets on edge, skeptical analysts promptly emerged, wondering if the BOJ is finally throwing in the towel and is preparing to join the ECB in tapering its bond purchases next:

SMBC Trust Bank

  • The increase was not enough
  • The market will test the BOJ further

Nomura (Peter Dragicevich, FX strategist)

  • Market looks to have been looking for a broader spectrum of purchase increases to reaffirm BOJ’s commitment
  • Market continues to test BOJ’s resolve with 10-year yields up a couple more basis points
  • But as BOJ minutes from December policy meeting noted this morning, some board members have called for flexibility in meeting the target

SMBC Nikko Securities (Souichi Takeyama, rates strategist)

  • BOJ has shown its willingness to contain rise in yields but seems to have failed to communicate well with markets
  • There were some expectations that BOJ would boost purchase amount more or may buy super-long-term bonds
  • With none of these expectations met, there is speculation BOJ isn’t serious about stopping rise in yields
  • The central bank may also be taking into account impact of its bond operations on the currency

Barclays (Naoya Oshikubo, rates strategist)

  • People expected BOJ to buy more, even in the zone of more than 10 years
  • The disappointing outcome accelerated the selloff in bonds

Should the 10Y yield continue to rise and fail to engender an appropriate response from the central bank, that would suggest that Kuroda is indeed tapering, and the time to aggressively sell the USDJPY has arrived.