AI view: Japan’s bond yield dilemma

We present the third in our series of predictions for the Year of the Rooster. Today: will the Bank of Japan be forced to re-think its 10-year bond yield target?
AI view: Japan’s bond yield dilemma

From an 'awkward' handshake to golf etiquette, the body language between the leaders of Japan and the US was minutely scrutinised earlier this month during President Donald Trump's meeting with Prime Minister Shinzo Abe in Tokyo.

This provided an appropriate backdrop to the tricky dollar-yen relationship—and its implications for Japanese government bond yields. The central bank's aim to keep them down to zero does seem to have had one of its desired effects: of encouraging investors to move into other assets, if domestic insurers' falling allocations to JGBs are anything to go by.

The question we posed on this subject remains a hotly debated one.

Scroll down for the others predictions we have made so far for the Year of the Rooster. The article will appear in full in the upcoming February/March issue of AsianInvestor magazine.

Will the Bank of Japan be forced to rethink its 10-year bond yield target?
Answer: No

The Bank of Japan set the goal of keeping 10-year government bond (JGB) yields at zero on September 21, 2016. Its intention was in line with its efforts of the past three years—namely to shift investors out of government debt and into other assets, hopefully bolstering market confidence and inflation.

Economists believe the BoJ has little need to shift away from this unconventional monetary goal over the coming months. The election of Trump has increased the difference between the controlled JGB yields and those of other countries, as a spate of selling of government debt widened the interest rate differentials of other developed nations against Japan’s zero yields.

That dynamic encouraged the yen to weaken as local investors put more money into other markets, although the dollar has risen against most currencies. The yen was trading at ¥113.16 to the dollar on February 23, versus ¥105.18 on November 8, the day of the US election.

The relative weakness of the yen is a boon for the earnings of Japan’s large export-focused corporates and could potentially underpin a modest level of inflation.

That said, inflation expectations should remain grounded. It’s likely Japan’s consumer price index numbers will only rise by a maximum of 1.5%, still below the 2% annual target set by the BoJ. Until this level is reached—assuming it ever is—the 10-year target is unlikely to change.

While an increase in oil prices has fed into rising costs, domestic earnings remain stagnant. Economists told AsianInvestor further monetary stimulus is likely this year.

For international investors in particular, a weaker yen offers potential opportunity in local equities. The potential for export-focused Japanese companies to become a lot more competitive would help improve their earnings and potentially share price performance.

Other Year of the Rooster forecasts:

How many rate hikes will the US make this year?

Will Donald Trump spark a trade war with China?

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