[Speaking Out] Is Bank of Japan Encouraging Speculative Trading in Government Bonds?

The Bank of Japan (BOJ) effectively raised the upper limit of its long-term interest rate to 1% at its monetary policy meeting on July 28. Governor Kazuo Ueda, who took office in April, has begun to revise the yield curve control (YCC) policy that was started during the time of his predecessor Haruhik o Kuroda.

However, this move could potentially encourage speculative trading in Japanese government bonds (JGBs) and foreign exchange.

Negative Effects of Boosting Interest Rates

The Japanese economy is now steadily recovering. That is thanks to the legacy of former Prime Minister Shinzo Abe's Abenomics economic policy, including unprecedented monetary easing. Not only the BOJ but also economic media that adjust to speculators' ulterior motives should not break the current virtuous cycle.

The BOJ's decision at the meeting on July 28 was to keep the upper limit of the benchmark 10-year JGB yield at 0.5% as a "target." But it would allow an actual increase of up to 1%. Ueda told a press conference after the meeting that the central bank would control speculative bond trading from spreading too much. However, the expansion of interest rate fluctuations itself could encourage speculative trading.

Impact on the National Economy

A 0.5% yield change roughly means a 5% change in JGB principal value. The trading volume of JGBs is huge, with an average of ¥134 trillion JPY (roughly $918 billion USD) per day as of June. This indicates that the fluctuation of the principal market is about ¥6.7 trillion JPY (roughly $46 billion USD) per day. This means that financial institutions that earn profits from trading JGBs would welcome the BOJ's decision. But it may exert negative impacts on the nation and the national economy.

*The Bank of Japan headquarters in Tokyo. (© Sankei)*

The JGB market is the cornerstone of the financial market. But it has a foreign share of more than 38% in trading, including investment funds that specialize in short-term buying and selling. This has overwhelmed domestic financial institutions that are trading partners with the BOJ, leading market trends. The rise in JGB yields means a decline in JGB prices. This hits the BOJ's assets, which had a JGB holding balance of ¥576 trillion JPY (roughly $3.9 trillion USD) at the end of March. But it also raises the government's JGB issuance cost and becomes an obstacle to fiscal management.

Foreign Funds Ready to Benefit From Future BOJ Decisions

On the morning of July 28, The Nikkei reported on its front page that the central bank would "tolerate" a long-term interest rate of over 0.5%. The long-term interest rate had been around 0.45%, but it began to wildly fluctuate. The report came before the BOJ's announcement.

After the BOJ's official announcement, the yield soared to 0.575%. It exerted ripple effects on American and European financial markets. The market fluctuation for the JGB that represents yen-denominated assets naturally spilled over to the foreign exchange market. This triggered speculative yen selling in Japan and abroad.

At the press conference, Ueda said, "If we are slow, side effects will expand." This indicates that he thought he had taken the initiative in making long-term interest rates flexible. However, foreign investment funds outside the BOJ's scope of influence will be encouraged by their profits from speculative trading on July 28. They will be watching for opportunities to break through the upper limit of 1% for long-term interest rates and even abolish YCC itself.

(A version of this article was first published by the Japan Institute for National Fundamentals. Find it in Speaking Out #1060 in Japanese on July 31 and in English on August 1, 2023.)

Author: Hideo Tamura

Hideo Tamura is a Planning Committee member at the Japan Institute for National Fundamentals and a columnist for The Sankei Shimbun newspaper.