The yen tumbles toward 33-year low. Is it the Bank of Japan's fault?

By William Watts

The Japanese currency fell sharply Tuesday, on track for its weakest close versus the U.S. dollar in 33 years, after the Bank of Japan took another baby step toward abandoning its controversial policy of yield-curve control.

The BOJ at its policy meeting effectively loosened its cap on long-term bond yields, saying that its previous 1% limit on the 10-year Japanese government bond BX:TMBMKJP-10Y would now serve as a "reference point."

Traders, it seemed, were expecting more after Nikkei on Monday reported that BOJ policy makers were likely to further loosen the yield-curve control policy after lifting the cap from 0.5% to 1% in July.

The U.S. dollar retreated versus the Japanese currency (USDJPY) following the report Monday, dropping to a two-week low below 149 yen. It rebounded sharply after the BOJ announced its tweak to the cap. It was up 1.6% at 151.445 yen in North American afternoon trade.

That would market its highest finish based on end-of-day levels since July 3, 1990, according to FactSet.

Surges above 150 yen by the dollar last year prompted rounds of intervention by Japanese authorities to stem the currency's weakness.

But analysts and economists argued that an incremental loosening of yield curve control, or YCC, and a slow walk toward normalization of monetary policy makes sense as the BOJ is the only major central bank where official interest rates remain negative.

"It is meant to be a gradual transition that takes place not via abandoning the existing policy framework but by making that framework increasingly flexible in response to the evolving macro setup," said Konstantinos Venetis, director of global macro at TS Lombard, in a note. "At the limit, flexibility becomes change."

The yen, meanwhile, is unlikely to find its footing until either the Federal Reserve begins to signal that it's at least thinking about future interest rate cuts or the Bank of Japan signals it's ready to lift rates, analysts said.

Meanwhile, the approach announced Tuesday is "way of softening what used to be the yield cap without repeating the July move and raising the cap 50bp (basis points)," said Krishna Guha, head of the global policy and central bank strategy team at Evercore ISI, in a note.

"We think of this as another step in an ongoing process of fading YCC so it becomes less and less binding and ultimately gradually becomes irrelevant," he wrote.

The July decision contributed to a surge in long-term government bond yields, including the rate on 10-year U.S. Treasurys BX:TMUBMUSD10Y. The move triggered a short-lived surge in the Japanese yen and was blamed for a downturn by major U.S. stock indexes.

Archive: Why U.S. stocks and bonds stumbled on talk of a Bank of Japan policy tweak (July 27)

A move away from YCC and the potential for the BOJ to become the last major central bank to move away from ultralow policy rates weakens one of the last remaining anchors on global bond yields, analysts said. Moreover, the prospect of a rise in JGB yields could see Japanese investors further shun U.S. Treasurys.

Of course, it's a two-way street. The slow approach taken by the BOJ appears to reflect a judgment that it can't stand in the way of spillovers from higher U.S. yields that would drive up JGB yields. That would force the BOJ into very large-scale purchases and risk extensive market dysfunction, Guha wrote.

But it also makes Japanese yields more vulnerable to being pushed higher by U.S. spillover effects if U.S. yields extend their recent rise.

As for the yen, BOJ policy makers were likely disappointed the currency didn't get more support, Guha said.

"We think the key to the Yen is when the BOJ starts to move on overnight rates rather than YCC," he said.

Venetis agreed that the setup leaves the yen exposed.

The yen won't see a "game changer" until the BOJ starts sending "hawkish undertones," he said.

"This means signalling it is high time that policy veered towards restrictive territory. As the market's focus then shifts from the 'end of YCC' to the 'end of NIRP (negative interest-rate policy),' Japanese real interest rates will adjust upwards and the yen will take its cue, repricing accordingly," he said. "It looks like that time is approaching, but we are not there yet."

-William Watts

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10-31-23 1503ET

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