The Bank of Japan shifted their yield curve control policy in July 2023 from an effective yield cap at 0.5% for 10-yr. bonds to 1.0%. The market didn’t really press yields too much higher than 0.5% until recently. There is a case to be made for yields to push towards 1.0% over the coming weeks, and then staying there for a considerable amount of time. The Bank of Japan is watching economic growth and inflation, like all the other central banks. The BoJ is different though as they have been fighting to lift inflation for over a decade now, so they may be wary of thinking that they have finally broken the back of below target inflation. They have had negative official rates since 2016 and at some stage they may want to push these back to ‘normal’ levels. What normal means after keeping rates below zero for over seven years is a guess, of course.
The chart below may be useful as a guide to potential future yield moves. There is a base in place and a push to 0.8% for a test of 1% seems likely. Technically, yields should be targeting the 2% area, where the JGB 10-yr. bond yield peaked in 2006/2007. Fibonacci ratio retracements point to 2.9% targets on a 38.2% retracement of the drop from 8.1% to -0.3%. This drop took over 30 years so it may take some time to retrace the fall in yields. Watch the 0.5% to 0.3% area on pullbacks. If this is really a big push higher building, then yields dips should remain constrained.
For investors, the push above 0.5% is best seen as a ‘wake up call’ if they are relying on low JGB yields. JGB yields may be set to push higher for some time, and this may bolster the JPY at some stage. Our long term forecast is still for the JPY to firm towards Y130/Y125 over the next year. In the bond, approaches to 1% will probably draw investor interest as many will take the view that the Bank of Japan's yield curve control measures will cap further yield rises. This may be the case through H1 2024, but at some point the BoJ may well take the view that official rates can be lifted, and that a cap on 10-yr. bond yields doesn’t suit them anymore. This may be the catalyst for yields to push higher again.
Gerry Celaya
Chief Strategist