JPY: Steepening of yield curve – Deutsche Bank

Taisuke Tanaka, Strategist at Deutsche Bank, notes that the yield curve in the JGB market has steepened ahead of the BoJ MPM on 21 September because of speculation that while the BoJ could expand negative interest rate (NIR), any adjustment to its JGB purchase framework would be tantamount to toleration of a rise in long-term interest rates.

Key Quotes

“While a steepening yield curve dampens the impact of portfolio rebalancing, under a NIR regime it improves costs at financial institutions, for investors such as lifers, and for pensions, and we thus think it can potentially strengthen the sustainability of ultra-easy monetary policy.

In Japan and Europe, NIR regimes have seen yields on many sovereign bonds turn negative. As a result, a considerable volume of funds has shifted into US bonds, which deliver positive yields (although low), and yields here have also declined. A substantial portion of recent US debt purchases by Japanese investors has been with currency hedging, which should normally be neutral for the JPY. However, lower yields due to unusually large purchases of US bonds have also exerted bear pressure on the USD/JPY rate.

In addition to declines in US bond yields, substantial demand for currency hedging has boosted the cost of actual hedging transactions, and this in turn has recently resulted in negative yields on investments in hedged US bonds. Therefore, Japanese investors have been seeking non-UST bonds and non-German EUR bonds to get positive post-hedging yields. Discussion of the limits of QE in Japan and Europe has spurred a steepening of the yield curve recently, and this in turn has led to a rise in US bond yields.

We expect that reinforcement of the sustainability of the BoJ's ultra-easy monetary policy, wider US-Japan short-term interest rate gap due to further cut of NIR, and rising US yields will likely work to reduce bear pressure on the USD/JPY. However, even if some leeway is accorded to BoJ policy, which has already been subject to debate about its limits, we think it is unlikely to become a trigger of substantial and sustained yen depreciation. Support at the 100-105 level may provide temporary reinforcement, but we cannot look for an impact beyond this.

In the JGB market, concerns about BoJ tolerance of a steepening yield curve naturally took precedence. However, this was not factored in sufficiently in the currency market, and we think reaction to today's Nikkei article has been substantial. Our prime condition for the USD/JPY sustaining firmness is still above all US economic confidence and expectations for multiple rate hikes increasingly favoring early action. In the absence of these factors, we continue to think that the USD/JPY is very likely to move toward a fall below 100.”