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HONG KONG, Dec 19 (Reuters Breakingviews) – Shorting the Bank of Japan (8301.T) is the trade of 2023. Gyrations in Japanese bond yields resulting from an abrupt increase in benchmark interest rates could force indebted domestic entities to dump overseas assets, roiling global markets. Portfolio rebalancing is already underway, but it will take a lot of really good news inside Japan for the shift to be bad news elsewhere.
The question on traders’ collective mind is what happens when the central bank finally adjusts its “yield-curve control” policy, or YCC, which has held down government bond yields for more than six years. The country is the single largest holder of U.S. Treasury bonds, and cross-border claims on Japan stood at $4.2 trillion at the end of June, according to the Bank for International Settlements, three times more than liabilities. Nomura estimates Japanese entities own $6 trillion in overseas assets, half of that unhedged.
When the U.S. Federal Reserve began hiking interest rates in 2022 the BOJ declined to follow: Japanese inflation excluding food and energy remains below its 2% target. The spread between yields on 10-year U.S. Treasury bonds and equivalent Japanese government securities widened, the yen plunged, and sceptical bond traders tested the 0.25% 10-year yield that the central bank pledged to defend. The yen’s slide pushed up hedging costs, forcing Japanese firms, insurers in particular, to unwind offshore positions.
YCC is the brainchild of BOJ Governor Haruhiko Kuroda, who is set to retire in April. His successor may feel freer to tweak the regime, especially if prices excluding food and energy keep rising. A higher-than-expected wage hike resulting from springtime negotiations could persuade officials that salaries are offsetting higher prices, bolstering the case for normalising interest rates. If government bond prices fall, investors who collateralised offshore loans with local debt securities could be in trouble.
A messy unwind remains unlikely, though. With Fed Chair Jerome Powell and his colleagues hinting at milder rate hikes, the yield spread has narrowed and the yen recovered. If Japan’s net overseas position reverts to where it was before the BOJ launched quantitative easing in 2013, Nomura estimates a manageable $500 billion could move out of foreign assets. Meanwhile higher interest rates would allow Japanese companies to earn better returns on their 325 trillion yen ($2.4 trillion) cash hoard. Japan had an earthquake, a tsunami and a nuclear accident in 2011 without setting off a global financial crisis. Investors betting on meltdowns have been disappointed before.
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CONTEXT NEWS
Japan’s government is set to revise a decade-old joint statement with the Bank of Japan that commits the central bank to achieving its 2% inflation “at the earliest date possible,” Kyodo news agency reported on Dec. 17, citing government sources. The new statement could remove the phrase “at the earliest date possible,” or change the language to clarify that the 2% inflation target is a medium- to long-term goal rather than one that needs to be achieved quickly, Kyodo said.
Prime Minister Fumio Kishida will discuss details on how to revise the statement with a new BOJ governor, who will succeed Haruhiko Kuroda when the central banker’s term ends in April, the report added.
Japan’s manufacturing activity shrank at the fastest pace in more than two years in December on soft demand and persistent cost pressures, a corporate survey showed on Dec. 16. The au Jibun Bank Flash Japan Manufacturing Purchasing Managers’ Index was down to a seasonally adjusted 48.8 in December from a final reading of 49.0 in the previous month. That is below the 50-mark that separates contraction from expansion and marked the sharpest decline since October 2020.
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