It’s Markets vs. Central Banks, and Traders Are Winning

(Bloomberg Opinion) -- Japan’s iron chef has been given an impossible task: raising a yield curve that’s flat as an okonomiyaki, or a savory pancake. 

The Bank of Japan has made controlling the yield curve a centerpiece of its monetary policy. The idea, initially, was to seek a happy medium that would keep borrowing costs low while nudging part of the curve high enough for banks to make a profit. But in recent months, yield curves have been flattening around the globe, most notably in the U.S., as investors fleeing negative rates pile into longer-dated bonds, pushing yields still lower. That buying has only accelerated recently as central banks, led by the Federal Reserve and European Central Bank, kick of fresh easing cycles. 

These forces are putting the BOJ in a bind. Just weeks ago, the yield on Japan’s 10-year government bond sank as low as -0.29% for the first time since 2016. As a result, the yield curve – measured by the spread between two-year and 10-year government bond yields – came close to inverting. The world now has close to $14 trillion of negative-yielding debt, with more than 40% coming from Japan.

The latest market moves also cast doubt on the central bank’s policy to tether the 10-year bond yield “around zero percent.” What’s the point of yield-curve control if the BOJ doesn’t have a well-defined trading band beyond which it will intervene? Plus or minus 0.2% would do the trick. Ultra-long yields have already “fallen a bit too far,” BOJ Governor Haruhiko Kuroda said earlier this month. 

This creates another uncomfortable situation for monetary policymakers. The BOJ has the tools to prevent its 10-year yields from rising: It can simply keep buying bonds in the open market. Yet there’s no good way to prevent them from falling, beyond tapering its purchases. That would be the exact opposite of easing.

If the BOJ wanted to point fingers, it could start with foreigners. Japan’s government bonds – despite offering negative yields – are now looking juicy to Americans. Thanks to a strong yen, Japan’s 10-year sovereign notes give dollar-based investors higher yield than their Treasury equivalent, once you account for currency hedging. The trend becomes more dramatic for longer maturities. 

Then there’s the immutable status of the yen as a haven. Whenever U.S.-China trade talks veer off-course, or a major oil plant gets attacked, investors can’t help but flock to the Japanese currency. But these days, any outright intervention to weaken the yen, or even talk to steer it, is off the table. U.S. President Donald Trump has been quick to label nations currency manipulators, and isn’t shy about using import tariffs as a weapon. That wouldn’t be a good backdrop for the U.S.-Japan trade deal that’s in the works.

One solution is to push short-term rates lower, which traders are nudging the BOJ to do. Signals from Tokyo indicate monetary policymakers, who meet later this week, are on board. 

Still, it’s unclear that cutting short-term rates can restore Japan’s yield curve. Meanwhile, negative rates only push its financial institutions toward riskier assets, such as high-yield bonds in Europe or collateralized loan obligations in the U.S. Already, about 30% of total investments by the country’s life insurers is overseas. 

Central banks around the world are losing control of the narrative – yield curves are just the collateral damage. For the Fed, it’s a result of Trump’s bullying, which has opened the door for traders to pressure Chairman Jerome Powell to deliver; for Japan, it’s a huge open market that’s testing the BOJ’s limits. China, by contrast, has no problem managing its yield curve, thanks to coordinated fiscal and monetary policies. 

The Fed’s inability to dictate the short-term rates that fund corporate bond purchases this week sends an alarming signal that even the short end of the curve is up for grabs. 

But then, is losing control such a bad thing? Central banks can’t solve all the world’s economic problems. Last week, even when the ECB re-launched quantitative easing, President Mario Draghi said it was “high time for fiscal policy to take charge.” Powell and Kuroda could certainly use a breather.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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