Will the Bank of Japan abandon its yield curve control policy?
Market speculation of an imminent change to—or even abandonment of—Japan’s yield curve control framework has been relentless. Having risen sharply through the past 12 months, volatility pertaining to the Japanese yen remains elevated with the framework coming under sustained pressure from multiple angles: the market, inflation, and politics.
YCC under sustained market pressure
When the Bank of Japan (BoJ) decided to tweak its yield curve control (YCC) policy and widen the tolerance band around its 0% target for 10-year yields from ±25 basis points (bps) to ±50bps in December, the central bank argued that the change would improve bond market functioning. Yet the latest survey of bond market participants found the share of participants who thought the market wasn’t functioning well hit a record high and the BoJ had to buy a record amount of Japanese government bonds (JGBs) in January.
BoJ outright purchases of JGBs hit another record in January
Source: Bank of Japan, Macrobond, Manulife Investment Management, as of February 20, 2023. BoJ refers to the Bank of Japan. YCC refers to yield curve control. JGB refers to Japanese government bond.
YCC under sustained pressure from inflation
There appears to be strong momentum behind rising consumer price inflation. Core inflation rose to 4.0% on a year-over-year basis in December, significantly higher than the BoJ’s 2.0% target. In addition, Japan's nominal wage growth rose to a 25-year high in December: Nominal wages rose 4.8% from a year ago after an upwardly revised 1.9% rise in November (from 0.5%),1 beating consensus forecasts for a 2.5% increase.2
YCC under sustained political pressure
In our view, the surge in inflation might have weighed on Prime Minister Fumio Kishida’s cabinet approval rating. A survey conducted by Jiji Press in January showed that support for Mr. Kishida and his cabinet fell to a record low of 26.5%. A separate poll conducted by national broadcaster NHK showed that approval ratings for Mr. Kishida and his team remain stuck in the mid-30s, a long way from last July when support was at around 60%.
Approval ratings for Japan Prime Minister Fumio Kishida and his cabinet (%)
Source: NHK, Macrobond, as of February 20, 2023.
Abandoning YCC isn't a done deal
Despite the above factors, we don’t think investors should assume that the BoJ will abandon YCC, particularly since inflation is likely to fall sharply in the coming months.
1 Inflation may start falling soon
The government’s utility subsidies have come into effect: As part of the Japanese government’s comprehensive economic stimulus package announced in October 2022, subsidies for electricity and gas will kick in from January and help to reduce monthly electricity and gas bills for average households by around 2,500 yen (JPY). Price caps introduced to curb energy costs are estimated to shave 1% from inflation.
2 A wage-inflation spiral is yet to be seen
The spike in wage growth appears temporary and indicators suggest we’re far from seeing a wage-inflation spiral. The big driver of the recent surge in wage inflation was a jump in volatile bonus payments, which climbed 7.6% after a 3.1% rise in November. Base pay, however, has remained relatively steady at around 1.9%, which is well below Consumer Price Index inflation of 4.0%+.2 Forward-looking indicators are suggesting that the labor market is weakening, implying that base-pay growth is unlikely to accelerate. Overtime hours are declining, and December’s Tankan survey painted an anemic picture as well—the survey’s employment conditions index has fallen sharply to a near-record low of -31. Overall, wage growth isn’t yet sustainably above the 3.0% rate that the BoJ has argued is needed to achieve sustained inflation.
The jump in wage growth in December was mostly due to a surge in bonus payments, YoY (%)
Source: Macrobond, Manulife Investment Management, as of February 21, 2023. YoY refer to year over year.
3 The nomination of Ueda as next BoJ governor
The main development in recent weeks was the nomination of Kazuo Ueda as the next BoJ governor. Mr. Ueda was present as a BoJ policy board member at the inception of the central bank’s zero interest-rate policy in 1999 and quantitative easing program in 2001, and has been known to lean dovish. But he left the board in 2005 and hasn’t played a prominent role in public policy debate since, and it isn’t readily apparent what his policy bias is. But the reality is that whoever takes on the BoJ governorship can expect to face the same issues as incumbent Governor Haruhiko Kuroda: The YCC framework may be under sustained pressure but there are compelling reasons to suggest inflation is still largely driven by cost-push factors, and the goal of stable inflation around 2% is still far from secure for the longer term.
4 Sustained JPY strength is likely only temporary
The JPY has appreciated significantly against the U.S. dollar (USD) in recent months. The sharp move from nearly 152 to ~127 per USD between October 2022 and January 2023 has in part been a function of the weaker USD over this period, but the movement over and above the USD’s fall reflects speculation of an imminent hawkish BoJ shift. As we have argued earlier, that’s far from a done deal. As of this writing, the JPY’s volatility- adjusted yield is deeply prohibitive to strategic long JPY positions. The rise in JGB yields could never compete with global rates and the gulf between market expectations and central BoJ policy guidance (to date) is—in our view—the perfect set up for heightened volatility through the early months of the BoJ leadership transition.
What to watch in the weeks ahead
Investors are likely to scrutinize Mr. Ueda’s current views in the coming weeks. Between his comments from parliamentary hearing sessions and upcoming inflation data, we should have a clearer sense of what to expect next. Understandably, a continued rise in prices will likely prompt further speculation of an imminent change in the YCC framework.
1 Statistics Bureau of Japan, as of February 20, 2023. 2 Bloomberg, as of February 20, 2023.
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