Yen Strengthens Amid Reports of Possible Policy Tweak by Bank of Japan

The yen showed strength against the U.S. dollar on Thursday afternoon as U.S. stock indexes slightly weakened and Treasury yields increased. This followed a news report suggesting that policy makers at the Bank of Japan (BOJ) would discuss a potential adjustment to the institution's yield-curve control policy. The proposed change would involve loosening the cap on long-dated government bond yields.

According to a report by Nikkei, it is expected that BOJ officials will address this matter during Friday's policy meeting. The revised policy would allow the yield on the 10-year Japanese government bond to exceed its current cap of 0.5% to some extent. However, details regarding the magnitude of the increase were not specified.

Since 2016, the Bank of Japan has implemented a policy known as yield curve control (YCC) to maintain low government bond yields while promoting an upward sloping yield curve. Under YCC, the BOJ purchases Japanese Government Bonds (JGBs) as needed to keep the 10-year yield below 0.5%.

Nikkei's report suggests that the proposed modification to YCC would enable gradual increases in the yield above 0.5%. At the same time, it would aim to prevent unexpected surges, thus allowing the BOJ to regulate market fluctuations caused by speculators.

Both domestic and global market participants closely monitor changes related to YCC. Back in December, when the BOJ raised the cap from 0.25% to the current 0.5%, it created significant repercussions in the markets. Investors were unsettled by the possibility of the Bank of Japan relinquishing its role as the last major central bank maintaining low interest rates.

The yen's strength and the market's reaction manifest the significant influence that the Bank of Japan's decisions have on global financial markets, particularly in relation to the yen-dollar exchange rate and bond yields. As policy makers deliberate on the potential policy tweak, the implications for various market participants will be closely observed.

BOJ Considers Shrinking Balance Sheet and Ending Yield-Curve Control Policy

The Bank of Japan (BOJ) is considering reducing its balance sheet and terminating its yield-curve control policy if it becomes feasible to achieve a sustainable 2% inflation rate after consistently falling short for many years, said BOJ Governor Kazuo Ueda in May.

While the yield on the 10-year Japanese Government Bond (JGB) has reached above 0.4%, it has remained below the 0.5% cap. Concerns have risen that the 10-year JGB yield could surpass this limit due to continued interest rate hikes by major central banks, including the Federal Reserve, over the past year. The weakening of the yen, which contributes to inflation pressures, has further fueled worries.

Following this report, the yen saw a strengthening trend, causing the U.S. dollar to decline by 0.6%, settling at a rate of 139.41 yen.

Simultaneously, U.S. Treasury yields experienced an increase, with the rate on the 10-year note (TMUBMUSD10Y) rising over 13 basis points to 3.987%.

In response to the report, U.S. stock indexes either erased or reduced their earlier gains. The Dow Jones Industrial Average (DJIA) dropped by 70 points (or 0.2%), putting its 13-day winning streak at risk. The S&P 500 (SPX) declined by 0.1%, and the Nasdaq Composite (COMP) saw a modest increase of 0.2%.

While U.S. equities have demonstrated solid gains in 2023, Japanese stocks have substantially outperformed them, with the Nikkei 225 (NIK) rising by 26% year-to-date compared to the S&P 500's increase of 18.7%.

See: Japan's stock market is surging upwards by 25%. Here are four factors that could contribute to sustaining this rally.