Will Japanese Bond Investors Come Home in 2023?

The Bank of Japan (BOJ) has long maintained an ultra-easy monetary policy, resulting in Japanese fixed-income investors venturing into global bond markets for higher yields. However, the recent move by BOJ to double its cap on the 10-year Japanese government bond from 0.25% to 0.5% in response to tight global monetary policies has left many wondering if Japan will exit its ultra-easy policy mode in 2023.

The Bank of Japan’s Likely Next Steps

Historically, the BOJ has changed its monetary policy towards the end of a global policy cycle. However, predicting BOJ’s next few steps has become challenging as global inflation is still under control. We expect the Fed to finish tightening and easing later this year, implying imminent BOJ tightening. However, market expectations contradict the Fed’s projections for the policy rate, creating significant uncertainty in the path of the BOJ.

In Japan, the normalization of monetary policy would begin by unwinding the negative interest-rate policy (NIRP) and yield-curve control (YCC), followed by adopting a more conventional monetary easing policy, such as quantitative easing. However, the YCC is currently under pressure, and the BOJ is likely to eliminate it before the end of the year to restore liquidity.

Japanese Bond Investors’ Response to BOJ Policy Actions

BOJ’s recent policy action has caused many to speculate whether Japanese bond investors will shift their holdings out of hedged foreign bonds and into yen bonds. However, it is unlikely to happen soon as the BOJ will still take time to reach a point where interest rates are higher than 1% for the 10-year JGB. Considering prevailing inflation trends, the correlation between US Treasury bonds and JGBs, and the yield differentials within the JGB market, Japanese bond investors are unlikely to come home soon.

Related Facts

• The BOJ raised its 10-year Japanese government bond cap from 0.25% to 0.5% in response to tighter global monetary policies.
• The Bank of Japan has long held an ultra-easy monetary policy, leading to Japanese investors venturing into global bond markets for higher yields.
• BOJ has historically modified its monetary policy toward the end of a global policy cycle.
• The normalization of monetary policy in Japan would begin by unwinding NIRP and YCC, followed by adopting a more conventional monetary easing policy, such as quantitative easing.

Key Takeaway

BOJ’s recent move to double its cap on the 10-year Japanese government bond and eliminate YCC has left many wondering if Japanese bond investors will return in 2023. However, it is unlikely to happen soon, considering the prevailing inflation trends, the correlation between US Treasury bonds and JGBs, and the yield differentials within the JGB market.

Conclusion

Japan’s economic situation remains uncertain, and the timing of BOJ’s policy action has made it difficult to predict the path for Japanese bond investors in 2023. The BOJ’s move to eliminate YCC before the end of the year to restore liquidity is a step towards normalizing monetary policy. However, it will unlikely entice Japanese bond investors into shifting their holdings to yen bonds soon.