Central Bank Interventionism

The New and Improved QQE – Now With Yield Curve Control

Much has been made of the Bank of Japan’s announcement yesterday – with mixed reactions across the board in a day when Federal Reserve Chairwoman Yellen disappointed by delivering a whole bunch of nothing by failing to announce a rate hike.

At its core, yesterday’s announcement from Governor Kuroda can be broken down into two parts: a) the government’s commitment to overshoot its long held 2% inflation target and b) the steepening of the yield curve in an attempt to undo the damage caused by the BOJ’s own move towards the implementation of a negative interest rate policy (NIRP).

There’s not a whole much to the first part of the BOJ’s two-pronged effort to revive the economy laggard economy: it will simply continue to expand the monetary base until inflation stabilizes above the price stability target of 2%. After three years of doing precisely this and with the CPI currently sitting at negative 0.5% – more or less where it stood when Mr. Kuroda became Governor of the BOJ back in 2013– it isn’t incredibly clear how doing more of the same should yield different results; but nonetheless, this appears to be the preferred policy at the moment.

Regarding the Central Bank’s newly announced policy of Yield Curve Control, it is an attempt to undo the damage wrought upon banks and pension funds as a result of the BOJ’s own NIRP. Yield Curve Control is to be achieved by a) pegging the 10-Year bond at around 0% while pushing up the yield on super-long maturity JGBs, and b) bidding up the price – and thus driving down the yieldof shorter maturity bonds: thereby avoiding a weakening of the Yen and allowing for infrastructure spending at a reduced cost.

World markets reacted positively to the announcement and the 10 Year JGB is currently trading at -0.027 after briefly touching positive territory.

However, as Chief Strategist of Economic Research at Rakuten Securities Masayuki Kubota points out in an astute piece (in Japanese) in the Toyo Keizai, the BOJ’s quantum entangled policy of both easing and tapering – of loosening its bond buying program of long-term bonds, while at the same time reaffirming a commitment to further easing should market conditions require such measures – can be viewed as tantamount to having your cake and eating it too.

As Mr. Kubota points out, as the Central Bank expands its purchase of short term bonds, will banks be content to pay the 0.1% penalty to park their money with the BOJ? Or will they instead opt to buy longer maturity issues? Should the latter scenario materialize, greater demand could send yields lower, therefore undermining Mr. Kuroda’s aim of controlling the yield curve at the longer end.