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How the Bank of Japan's yield curve control could affect U.S. capital markets?


The Bank of Japan (BOJ) announced on July 28, 2023, that it was changing its yield curve to bring “greater flexibility” to its monetary policy, which came as a major surprise in global financial markets.

The loosening policy in yield curve control (YCC) means that the BOJ will now allow 10-year Japanese government bond yields to fluctuate in a wider range around its 0% target. Previously, the BOJ had capped the range at 0.5% above or below 0%. The recent rise in inflation, a weakened Yen, and pressure from investors have made Kazuo Ueda, the Governor of the Bank of Japan, apply more loosening monetary policy.

“Governor Ueda described the move as enhancing the sustainability of monetary easing rather than tightening. It sends a signal that the BOJ is not yet ready to tighten monetary policy through raising interest rates,” said the Bank’s analysts in a note. This change in the yield curve has some important implications.

First, it leads to higher bond yields. Indeed, the loosening of the YCC policy will likely lead to higher bond yields in Japan. This is because investors will no longer be as confident that the BOJ will intervene to keep yields low.

Second, the loosening of the YCC will continue the weakening of the Yen as investors adjust their portfolios in response to the change in the YCC policy. And third, the weakening of the Yen is likely to boost Japanese exports, which could lead to higher stock prices. Now it is important to know how the YCC will impact U.S. capital markets.

The BOJ's YCC policy has kept Japanese bond yields artificially low, which has made US bonds more attractive to Japanese investors. However, if the BOJ allows bond yields to rise, it could lead to a sell-off in US bonds as Japanese investors shift their money back to Japan. This could drive up US interest rates, which would make it more expensive for businesses to borrow money and could slow economic growth.

A stronger Yen, however, could also lead to rising stock prices in the US, as Japanese investors would have more money to invest in US stocks. However, if US interest rates rise too high, it could lead to a sell-off in US stocks as investors become more risk-averse.

The effectiveness of the BOJ’s YCC has been questioned, with some experts arguing that it distorts the natural functioning of markets. Kit Juckes, strategist at Societe Generale, said in a note to clients, the following:


“Yield curve control is a dangerous policy which needs to be retired as soon as possible. And by anchoring JGB (Japanese Government Bonds) yields at a time when other major central banks have been raising rates, it has been a major factor in the yen reaching its lowest level, in real terms, since the 1970s. So the BOJ wants to very carefully dismantle YCC, and the yen will rally slowly as they do so.”


As a matter of fact, the YCC impacts three categories of actors in U.S. capital markets. It impacts banks, investors, and the global economy.

As mentioned earlier, banks make most of their money by borrowing and lending at different interest rates. If the yield curve inverts, it can make it more difficult for banks to make a profit. This could lead to a slowdown in lending activity, which could have a negative impact on the economy. Moreover, investors who are holding long-term bonds could see their returns decline if interest rates rise. This could lead to a sell-off in these bonds, which could have a negative impact on the stock market. And lastly, the BOJ's decision could have a ripple effect on other economies, as investors adjust their portfolios in response to the change. This could lead to volatility in global markets.

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