Bank of Japan relaxes control over government bond yields, causing a sharp rise in the Japanese yen! Is this a good thing or a bad thing?

The Bank of Japan announced a surprising decision at today's monetary policy meeting, raising the upper limit of the 10-year government bond yield to 0.5%. This move not only breaks the restrictions in place since 2016 but also leads to a rapid increase in the value of the Japanese yen. However, what impact will this policy have on Japan and the international markets? Why is Japan once again controlling the yield curve for an extended period?

Japan Adjusts Upper Limit of 10-Year Government Bond Yield

During today's monetary policy meeting, the Bank of Japan's Policy Board announced an adjustment to its Yield Curve Control (YCC) policy by raising the upper limit of the 10-year government bond yield from 0.25% to 0.5%.

The Bank of Japan stated that since the beginning of this year, increased volatility in overseas financial and capital markets has led to a deterioration in Japan's bond market operations, particularly in the relative relationships between various bond rates and arbitrage relationships between the spot and futures markets. The government bond (JGB) yield serves as a reference rate for corporate bond yields, bank loan rates, and other financing rates. To prevent a further deterioration in market conditions that could negatively impact the issuance conditions and financial situations of corporate bonds, the Bank decided to make adjustments to its YCC policy.

Following the announcement, the 10-year government bond yield in Japan rapidly rose, surpassing the 0.25% upper limit in place since 2016, reaching approximately 0.426% at the time of writing.

Additionally, the Japanese yen saw a significant appreciation today of around 3.35%. For many Taiwanese who enjoy traveling to Japan, the yen depreciation had prompted them to buy more yen, but today's surge has pushed the yen to its highest level against the New Taiwan Dollar in nearly six months.

However, why does the YCC policy have such a significant impact on the Japanese economy and the yen's price, and what potential changes could occur in the market in the future? Let's revisit an article published by BitMEX co-founder Arthur Hayes in July.

Full article: Arthur Hayes on YCC - What is the Bank of Japan doing by manipulating interest rates? What are the consequences of severe yen devaluation?

Arthur Hayes on YCC

Arthur Hayes mentioned that since the bursting of the Japanese real estate bubble in 1989, the Japanese government has been combating deflationary effects of asset bubbles by printing money. Eventually, the Bank of Japan started manipulating the yield curve by controlling the prices of Japanese government bonds (JGB) to achieve the expected inflation.

But how does the YCC in Japan work? Historically, the Bank of Japan has set an upper limit on the 10-year government bond yield. When the limit is at 0.25%, the Bank of Japan will buy an unlimited amount of JGB until the yield falls to or below 0.25%. However, when the Japanese government bond yield is significantly lower than that of other countries, it will lead to capital outflows from Japan, resulting in a decline in the exchange rate.

As shown in the graph below, when the yield spread between U.S. and Japanese ten-year government bonds widens, the USD/JPY exchange rate continues to rise. Conversely, Japan's relaxation of the 10-year government bond yield has led to the appreciation of the yen.

However, why did Japan begin the YCC policy in 2016?

Arthur Hayes mentioned that since the implementation of negative interest rate policy in 2016, banks in Japan have been unable to attract deposits. To keep Japanese banks profitable, they have been offering a variety of structured products. The simplest and most widely issued concept is the "callable deposit," similar to callable bonds.

For example, with a 20-year callable deposit, the deposit rate is 0.25%, higher than a regular bank deposit. If the deposit rate decreases the following year, the bank can request the return of the deposit. However, if the deposit rate rises and the user wants to withdraw the deposit, it will result in a certain amount of loss. Over the past few years, deposit rates in Japanese banks have been continuously decreasing, leading most users to treat them as 1-year deposits rather than 20-year ones.

If Japan were to abandon the YCC and reverse the trend of declining rates, users' short-term deposits would turn into long-term ones. For many depositors who need to withdraw the deposit on a regular basis, this would lead to widespread losses. Therefore, Arthur Hayes believes that the Japanese government's decision to maintain control over market rates is more prudent than making a move equivalent to political suicide. Although the YCC will impact the economy, there are reasons for its continuation.

If Arthur Hayes's logic is correct, the recent change in Japan's YCC policy will undoubtedly have a certain impact on the Japanese people. However, the true reasons behind the Bank of Japan's decision to make this move at this time, whether due to the pressure of massive bond purchases to maintain rates or as a deliberate exit from loose monetary policy towards rate hikes, remain uncertain.

A Storm is Brewing?

Additionally, according to the perspective of Facebook page Wang Bodai, Wang Bodai stated:

"The Bank of Japan initiated interest rate hikes in 1989, 2000, and 2006. The first time resulted in the largest bubble burst in Japanese economic history, the second coincided with the dot-com bubble in the U.S., and the third was the U.S. subprime crisis. These phenomena are not coincidental..."

How will the future of the world economy unfold?