The Bank of Japan undoubtedly set off the last global policy "thunder" in 2022 today. Almost no one could have imagined that Haruhiko Kuroda, the outgoing Governor of the Bank of Japan next spring, would suddenly "sing" such a "big drama" that would shock the global market before

The Bank of Japan undoubtedly set off the last global policy "thunder" in 2022 today. Almost no one could have imagined that Haruhiko Kuroda, the outgoing governor of the Bank of Japan next spring, would suddenly "sing" such a "big drama" that would shock the global market before the end of his term. And it happened to be at such a time - in a few days, the European and American markets will usher in the Christmas holidays.

I believe that in the past few hours, many Wall Street traders who were still sleeping in their beds at midnight would be awakened by the ringing of their colleagues' phones, then turn on their computers with confused eyes, and finally be frightened by the violent fluctuations in the Japanese yen, U.S. stock futures, U.S. bonds and other targets.

In fact, some older traders have associated today's fluctuations with a "Christmas past" in 1989 - during the Western Christmas holiday, the Bank of Japan staged a interest rate hike , giving European and American traders a big "surprise".

"About this time 33 years ago, the Bank of Japan was also dissatisfied with the exchange rate of the US dollar against the yen, and then raised the interest rate by 25 basis points to 4.5% on Christmas Day," Martin Whetton, director of fixed income and currency strategy at the Commonwealth Bank of Australia, said from the old almanac.

So, what did the Bank of Japan do today? Why did global financial markets react so dramatically? Here, we briefly answer four major doubts that may exist in the market.

Question ①: What major decisions did the Bank of Japan make today?

The main change that caused market fluctuations today was the unexpected announcement by the Bank of Japan to modify the yield curve control plan (YCC), raising the yield target from ±0.25% to about ±0.5%.

There may be financial novices who are still confused after reading the above paragraph. So let’s use an intuitive chart to speak: The Bank of Japan’s previous YCC policy was to limit the 10-year JGB yield to 0.25%, which is the initial position of the arrow in the chart. Now, the Bank of Japan has relaxed this limit to 0.5%.

Since 2016, the Bank of Japan has set the fluctuation target range for the benchmark 10-year Japanese government bond yield near zero as a means of maintaining low interest rates in the overall market.

As we all know, a country’s benchmark 10-year Treasury bond yield is often a key benchmark for the country’s borrowing costs. By steadfastly guarding the 10-year government bond yield, the Bank of Japan can act as an anchor and indirectly help keep Japan's borrowing costs among the lowest in the world.

Obviously, the Bank of Japan relaxed the scope of the YCC policy today. Although it is by no means equivalent to an interest rate increase, it does have the effect of "quasi-rate increase" in a short period of time. This is very intuitively reflected in the fluctuations in the 10-year Japanese bond yield. After the Bank of Japan's decision was announced, the 10-year Japanese bond yield quickly soared from the original 0.25% to over 0.45%. At least in terms of the 10-year JGB yield, that's almost equivalent to a "rate hike" of about 25 basis points in a matter of minutes.

Similarly, after the announcement of the Bank of Japan's decision, many people may have only focused on the plummeting of Japanese stocks, but in fact, Bank of Japan stocks bucked the trend and soared during the session today. Japan's largest banks Mitsubishi UFJ Financial and Sumitomo Mitsui Financial once rose more than 8%. That's because today's unexpected move by the Bank of Japan is a positive sign for these financial companies, whose interest income has been crushed by the Bank of Japan's low interest rate policy for years.

Question 2: What led the Bank of Japan to make this decision today?

So, what is the reason that caused the Bank of Japan, which has long maintained a dovish stance, to suddenly decide to modify the YCC policy today?

Some market participants thought after the Bank of Japan's decision that the Bank of Japan's change today was based on the exchange rate - the Japanese yen was still the weakest G10 currency during the year, but we think not. The reason is simple. The Bank of Japan did not resort to this big move when the yen exchange rate fell the most in September/October this year, and now that the yen has rebounded sharply in the fourth quarter, it is even less necessary.

In fact, as the Bank of Japan said, what led the Bank of Japan to make this change may be the bond market itself.

The Bank of Japan said in a statement today that it decided to adjust its control of the yield curve to improve market functions and encourage a smoother formation of the entire yield curve while maintaining a loose financial environment. Through these steps, the Bank of Japan will work to strengthen the sustainability of monetary easing under this framework to achieve the price target.

In its policy statement on Tuesday, the Bank of Japan did not cite inflation as a reason for allowing JGB yields to rise to 0.5%, instead citing deterioration in the functioning of the bond market and the difference between the 10-year yield and other maturities.

Interestingly, just before today's Bank of Japan decision, a newly released statistics showed that the Bank of Japan's holdings of Japanese government bonds exceeded the historic threshold of 50% for the first time. According to the latest quarterly data released by the Bank of Japan on Monday, as of the end of September, the central bank held 50.3% of the total treasury bonds, up from 49.6% three months ago. The central bank has been buying Japanese government bonds as part of its yield curve control policy, which itself has raised concerns about crowding out private investors and exacerbating the depletion of market liquidity.

Deutsche Bank said in October this year that the Bank of Japan’s firm commitment to unconventional easing policies and its unwillingness to give up yield curve control (YCC) were full of “self-deception.” The most intuitive thing is the yield curve graph - a "break" appears directly near the 10-year yield that is firmly controlled by the Bank of Japan: as early as October, there were only three 10-year government bonds that were in line with the Bank of Japan's fixed-rate purchase business. The yields were below the 0.25% yield ceiling. The yields of bonds that mature on both sides of the target period are far higher than the upper limit set by the central bank.

Bank of Japan Governor Haruhiko Kuroda also admitted at the press conference after today’s meeting that the (bond) market function is declining.

Question 3: Why is the global financial market reacting so strongly today?

This question can be answered from two levels.

The most intuitive thing is the direct impact of the Bank of Japan’s policy changes on the financial market. As we introduced in our earliest market reaction report, this signals that the market will generate expectations that Japan, the last country in developed markets to insist on low interest rates, may also be beginning to move towards policy normalization (even if the Bank of Japan still does not admit this).

In other words, what the market is most afraid of is: after today, there will be no central banks in the world with monetary easing.

Another more critical impact is the flow of global funds. In late October, we discussed "The depreciation of the yen is no longer a question of how much it will fall?" A detailed introduction was made in the article "Beware of the "Nuclear Explosion" Button in the Global Market". Here are some brief excerpts from the article:

Globally, the huge capital accumulation from Japanese pension funds and even retail investors has always been a force that cannot be underestimated. The most significant macroeconomic impact is the repricing of the global term premium (the extra compensation investors need to hold longer-dated bonds).

Japan’s continued demand for foreign debt has been an important driver of low developed market yields, so a reversal in policy could lead to the unwinding of these positions and push government bond yields higher in other developed markets such as the United States or Europe. If the YCC policy is completely reversed, it will further promote the sell-off in the global bond market and trigger a wave of funds flowing into Japan from U.S. Treasury bonds and other overseas assets.

In fact, today’s surge in U.S. bond yields has such a meaning in it. You know, last Thursday, when the European Central Bank's hawkish interest rate hike led to a sell-off in European debt, U.S. bond yields did not rise as much as they did today.

Question 4: Does today’s policy move mean that the Bank of Japan will turn around?

If you ask this question directly to Bank of Japan Governor Haruhiko Kuroda, he would have already answered you at the press conference more than an hour ago: "No"!

Haruhiko Kuroda bluntly stated at the press conference that it is too early to discuss exiting easing policy - expanding the yield curve control range is not equivalent to raising interest rates, nor is it a step towards policy normalization.

Kuroda also said that if necessary, he would not hesitate to further relax monetary policy , because the loose policy has brought about a non-deflationary environment. He still expects Japan's CPI growth to slow down in the second half of next year, imported inflation will begin to subside, and overall inflation in the 2023 fiscal year is unlikely to reach 2%.

Obviously, after today's hawkish interest rate decision, Haruhiko Kuroda was trying his best to promise that he was still a "dove" at the press conference after the meeting. But the most interesting thing is actually the market reaction. After Haruhiko Kuroda's speech, the yen gave up a small part of the day's gains - about 60 points.

then...well, it went up again! The U.S. dollar has hit an intraday low of 132.28 against the yen.

​We reported yesterday that there were reports from Japan and the United States last weekend that the Japanese government is planning to revise a 10-year-old joint statement with the Bank of Japan and will consider adding flexibility to the 2% price target of the agreement. Although this revelation was subsequently denied by Japanese government officials, speculation surrounding whether the Bank of Japan will make major policy changes after Governor Haruhiko Kuroda's term ends next year has never dissipated.

Today’s decision by the Bank of Japan to expand its yield target will only increase market speculation about a complete turnaround by the Bank of Japan next year. Now that the Bank of Japan has taken the first step to expand the range, who knows whether it will completely cancel the YCC policy one day?

Guotai Junan Futures stated that although the Bank of Japan explained that the move during the day was a consideration of the effectiveness of the micro-financial market functions and declared that this action "can enhance the sustainability of monetary easing," it cannot prevent the market from speculating that the Bank of Japan will gradually withdraw from the long-term "ultra-loose" monetary policy and start the normalization of monetary policy.

(Source: Financial Associated Press)