Haruhiko Kuroda might have set his sights on Japan, but his latest move is turning out to have far-reaching consequences for bond markets all over the world.
Almost two weeks ago, the Bank of Japan governor unveiled a plan to anchor yields on 10-year bonds at around zero, after trillions of yen of quantitative easing and the introduction of negative interest rates failed to revive the economy. While the shift was ostensibly aimed at helping the financial industry and quashing deflation, investors far and wide responded by pushing yields lower. From Japan to the US and Europe, volatility all but vanished and correlations rose to levels rarely seen in the past.
It’s perhaps the clearest example yet of how the drastic steps that central banks have taken to revive their economies following the financial crisis have imbued just about every facet of today’s $100tn global debt market - even as more and more question whether they’re running out of options.
In the early years, the Federal Reserve and the BoJ exerted their influence by aggressively buying bonds. Then, the European Central Bank led the move among major central banks into negative rates. Now, the BOJ’s decision to shift away from its “shock-and-awe” approach to stimulus is calling attention to the limits of monetary policy in a world where tepid growth, a lack of inflation and ageing societies have conspired to keep yields lower for longer.
“They are going to converge,” said Mizuho Asset Management’s Yusuke Ito, referring to global bond markets. “Economies are more and more intertwined. Add in demographics – all the countries are somewhat similar.”
Ito, who helps oversee about $50bn as Mizuho Asset’s senior fund manager, predicts bond yields will all eventually meet at the same level.
It’s already starting to happen. Demand for bonds worldwide has pushed down average yields for all types of investment-grade debt to 1.13%, less than 0.1 percentage point from the record low, according to the Bloomberg Barclays Global Aggregate Index. In more than half of the developed markets tracked by Bloomberg, yields on 10-year government bonds are under 1%, with many near or below zero. The difference between those in the US and Japan has dropped by almost half in the past decade to 1.68 percentage points.
The latest bond rally came after the BoJ refrained from another rate cut and introduced its “yield curve control” policy on September 21. In the weeks leading up to the move, bonds retreated in anticipation of a bold policy move to spur inflation. While the announcement itself initially suggested the BoJ wanted to steepen the yield curve, or increase the amount of income long-term bonds pay over shorter ones, it disappointed economists who had hoped for more. Kuroda later explained the policy would keep yields roughly at current levels, which many traders interpreted as a cap – at home and abroad. “I really don’t think you can justify a major selloff in the market, particularly with what the BoJ has done,” said Roger Bridges, chief global strategist for rates and currencies at Nikko Asset Management’s Australia unit, which oversees $14.6bn. “Correlations between bonds are increasing all the time.”
The move has sucked much of the turbulence out of bond markets. Implied volatility for 10-year Japanese debt tumbled by the most since 2008 on the day of the BoJ’s announcement. Expected price swings in Treasuries plummeted to a two-year low, while those on German bunds have also declined.
They’re also moving more in tandem. Benchmark bond yields in the US and Japan have stuck within half-percentage point range this year, the narrowest in at least three decades. The spread between the US and Germany has held in the tightest annual range in at least 27 years.
That partly reflects how Japan has come to the fore in the world of fixed income. And it’s occurring at a time when the BoJ’s outsize presence in the $10tn market has crowded out investors and left some securities untraded on certain days. A limit on Japanese yields risks sending investors flooding into overseas debt markets, keeping a lid on yields globally.
It’s already spurring a resurgence in Japanese purchases of foreign bonds, which rose to the highest since July in the two weeks ended September 23.
But just as important is the growing recognition among bond investors that deeper structural forces like demographics and wealth inequality – which may depress growth and inflation for years to come – are probably beyond the reach of even the most aggressive central bank policies.