Investors Pile Pressure on Yield Curve Pioneers Japan, Australia

Investors are pushing the world’s only practitioners of yield-curve control -- Japan and Australia -- toward decisions on the future of their pioneering monetary policies.

The Bank of Japan looks set this week to adjust a program that targets 10-year yields to make it more sustainable -- likely handing a lifeline to bond traders and pension funds who have been pushed to the edge by four-and-a-half years of YCC and more than two decades of near-zero interest rates.

The Reserve Bank of Australia finds itself in a very different position -- tussling with the market about how soon it may exit the three-year yield regime it started just 12 months ago. The clearest sign of this will come if and when it shifts purchases from securities maturing in April 2024 to those due in November 2024.

What happens in Japan and Australia is also crucial to global investors, who continue to pile into reflation trades, and by policy makers trying to keep a lid on borrowing costs through bond-buying programs that are creating mountains of debt.

“Credibility and patience are going to be the catch cry for central banks globally,” said Bill Evans, chief economist at Westpac Banking Corp. in Sydney. He suggests they may be ready to stare down markets after years of falling short of their goals on inflation and wages.

Investors Pile Pressure on Yield Curve Pioneers Japan, Australia

The two countries arrived at YCC under very different circumstances, drawing them toward opposite ends of the yield curve and setting the scene for the choices they face now.

Japan had been in and out deflation and the short end of its yield curve was depressed by years of ultra-low policy rates and aggressive bond buying when it embarked on the new experiment in 2016. That made 10-year yields a logical choice for Governor Haruhiko Kuroda.

By contrast, the RBA arrived at YCC in March last year just as its policy rate hit the lower bound and the nation searched for a way to mitigate the economic impact of a once-in-a-century pandemic.

“The 10-year yield is the most symbolic maturity in the Japanese market and the BOJ picked it to make the most impact,” said Hiroaki Muto, an economist at Sumitomo Life Insurance Co. “The BOJ’s main concern isn’t exiting -- given its inflation target is so far off -- it’s about keeping stimulus in place for a long time and reducing negative side effects.”

Investors Pile Pressure on Yield Curve Pioneers Japan, Australia

The RBA made no secret of studying the lessons learned from Japan and the difficulty of exiting unconventional policy before crafting its own framework.

Governor Philip Lowe settled on the three-year yield partly because much of the lending and borrowing in Australia occurs at the short-end. Targeting the three-year yield has also doubled for Lowe as forward guidance, with the RBA emphasizing it is unlikely to raise rates until 2024 at the earliest.

“They were focused at the outset on trying to get the market in the mindset that this is not forever,” said Belinda Cheung, director of credit strategy at the Commonwealth Bank of Australia. “The challenge is if you remove those stimulatory settings what you’re going to see is the exchange rate appreciate against our trading partners. This the clincher because that will cost jobs.”

The RBA has had a taste of this already, with the Australian dollar surging to 80 U.S. cents last month amid bets for a global recovery and a return to more normal monetary settings sooner rather than later.

It has also seen volatility in the yield spread between April 2024 and November 2024 bonds. This has narrowed recently as the RBA convinced more investors that YCC won’t end early.

Investors Pile Pressure on Yield Curve Pioneers Japan, Australia

“Japan can take a little pride in another one of its monetary policy innovations being adopted by another country, imitation being the sincerest form of flattery,” said Paul Sheard, a senior fellow at Harvard University’s Kennedy School, who hails from Australia and spent many years as an economist in Tokyo.

BOJ officials, in their policy review due out Friday, are looking at ways to enable 10-year yields to move more around their zero percent target. They want to improve the functioning of the bond market and reduce side effects on investors including insurers and pension funds, who depend on yields to generate income and match long-term liabilities.

Traders have pushed yields to as high as 0.175% over the last month in a spurt of volatility as they speculate on the outcome of the review, with every word from Kuroda and BOJ officials parsed for clues.

Lowe and his lieutenants are under similar scrutiny, with traders awaiting a speech from Assistant Governor Christopher Kent Wednesday and his comments at a webinar on Thursday.

“It’s a very technical policy -- you have to specify securities, and the transition from what you’re targeting to the next segment of the curve is a bit messy,” Julia Coronado, a former Federal Reserve economist and founder of MacroPolicy Perspectives LLC, said of YCC. “One of the lessons from unconventional policy is you can’t easily exit, unless you go big.”

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