Daniel Moss

Bond Traders Are Good at Sniffing Out Surprises

Bank of Japan Governor Haruhiko Kuroda’s commitment to massive stimulus is being tested. Such is the conviction that inflation and rates will jump around the world that even Japan, which has wrestled with deflation, is seen as a worthwhile bet.

This week, yields on 10-year government bonds have climbed within a whisker of the BOJ’s ceiling of around 0.25%, as traders speculate whether it will step in with a super-sized market intervention to keep levels from rising. Authorities haven’t done so — yet. So the guessing about whether, when and how the bank expresses its displeasure with the situation continues.

Investors are right to probe the bank’s resolve. In January, Kuroda went so far as to say it was “unthinkable” that rates would rise. Sounds pretty categorical. What markets are learning, however, is that there’s room for interpretation. For one thing, the bank has scope to maneuver without nudging the benchmark rate, currently negative, higher. Quantitative easing can be tweaked, as can the levels around zero on the 10-year bond that the BOJ seeks to control.

Then there’s Kuroda’s history of surprises to consider — and the times he’s done exactly what he appears to have ruled out. In January 2016, he threw shade on the idea that interest rates in Japan would be cut to negative territory, but days later did precisely that. In 2018, he doubled down on “continuous powerful monetary easing” while also loosening the reins on 10-year debt to allow yields to move up slightly. A good rule of thumb is to watch what the BOJ does, as much as what it says.Even before he took the helm in 2013, Kuroda understood the perceived power of surprise. As a senior bureaucrat at the Ministry of Finance, he decided when and at what levels Japan would buy and sell yen. Kuroda was a protege of Eisuke Sakakibara, the official nicknamed “Mr Yen” for his propensity to outflank — and upset — markets. In any case, Kuroda can only speak for his remaining time in office. The governor’s second five-year term ends in April next year.Yield curve-control has meant different things to different people since it was introduced in 2016. The BOJ said then it was aimed at making long-term easing more sustainable by focusing on the level of yields, not how many bonds it had to buy to get there. If investors were feeling optimistic about the economy and yields were inclined to rise, the bank wouldn’t need to flood the market with quite so much cash, so the argument went. It’s also been seen as a way to execute stealth tapering, as in 2018 when the target’s wiggle room was widened to 20 basis points around zero. Later that year, Kuroda’s public remarks could be read as laying the ground for the beginning of an exit from infinity QE. The pandemic came along in 2020 and any talk of withdrawal evaporated.

What else was happening in 2018? The Federal Reserve was raising interest rates, the US labor market was robust and the global expansion that began in 2010 was going strong. Higher inflation was expected, even welcomed. That it failed to materialize was a “mystery,” according to then-Fed chair Janet Yellen.

Today’s dilemma in Japan is whether to take Kuroda literally or seriously. The official rate probably won’t rise on his watch — or in the foreseeable future. But some whittling around the edges is quite conceivable, especially as April 2023 approaches.