TOKYO -- The Bank of Japan faces a growing battle with investors to defend its yield target as overseas players bet on rising rates in the U.S. and Europe to eventually force the bank to shift its monetary policy.
At 10:10 a.m. on Wednesday, the BOJ caused a stir among market participants when it notified them that it would carry out market operations to target a yield of around zero.
Under its yield curve control strategy, the central bank had so far focused on defending its 10-year-yield cap of around 0.25% -- mainly through fixed-rate operations, where it purchases unlimited amounts of new 10-year Japanese government bonds. Wednesday's notification expanded BOJ's target for fixed-rate operations to JGBs with as little as seven years left to maturity.
The shift comes as Japanese government bonds face mounting pressure from rising American and European interest rates. Because the BOJ had been defending only the benchmark 10-year yield, yields on bonds with seven to nine years left to maturity surpassed the rate for new 10-year JGBs this week -- a major anomaly, given that longer maturities normally mean higher yields.
Overseas investors see this as a sign that the BOJ may soon need to adjust its monetary policy. They are now selling off Japanese bond assets, especially futures and other derivatives.
London-based BlueBay Asset Management told Nikkei that it is building a sell position on Japanese bonds using futures and swaps.
"Given the weak yen and price levels, it is extremely unlikely that the BOJ will conduct additional monetary easing or implement a policy that would significantly reduce long-term interest rates," a BlueBay representative said of the firm's perspective. BlueBay may also be expecting the central bank to let rates rise in the near future.
Japan's 10-year JGB yield climbed to 0.255% on Monday, surpassing the BOJ's target of around 0.25%. This means that bonds sold for a lower price than was offered by the central bank, hinting at the market's waning confidence in its monetary policy.
The BOJ has responded by doubling down on bond purchases. It offered to buy 950 billion yen ($7.05 billion) in Japanese government bonds on Tuesday in addition to the fixed-rate operation. On Wednesday, it not only expanded its target for fixed-rate operations, but also purchased 1 trillion yen more in bonds than it had planned.
This is not the first standoff between a central bank and overseas investors. In 1992, the Bank of England tried to defend the pound against Germany's deutsche mark under Europe's old Exchange Rate Mechanism. American investor George Soros "broke" the bank that September by aggressively short-selling the pound.
Currencies and bonds are two separate markets. Still, "both cases share the same basic setup," said Takahide Kiuchi, executive economist at the Nomura Research Institute.
"As inflation pushes up U.S. interest rates, Japan's long-term rate, which has been fixed by the BOJ, is diverging from underlying economic fundamentals," Kiuchi said. "It will come under attack unless U.S. rates settle down."
"There is no limit" to the amount of government bonds the BOJ can buy, according to a source at the central bank. But the Reserve Bank of Australia, which had pursued similar policies, was forced to scrap its three-year-yield target this past November in response to upward pressure on interest rates.
Even without a hard ceiling, bond purchases can lead to side effects like distorted yields and a weak yen. The yen softened to the mid-135 range against the dollar at one point Wednesday, and there is concern that the resulting increase in consumer prices could trigger public backlash against the BOJ's policies. The central bank is expected to examine current economic conditions and prices as well as future policy at its next two-day policy meeting, which starts Thursday.