Currency market: BOJ preview, monetary policy and YCC

Since 1992, the BOJ battle and goal was raise Inflation levels from low and negative to achieve the 2% target to satisfy the BOJ's price stability mandate. In 31 years, Inflation achieved the 2% target in 2022 and 2014. Inflation was negative in 15 of 31 years and slightly above 1% for 6 years.

After ABE's 3 Arrows approach to monetary policy, Kuroda in 2013 adopted the 2% Inflation target while introduction of Quantitative easing or adoption of a loose money supply. Short term rates were targets at 0 then into negative territory in 2016 as Quantitative easing failed to raise Inflation. The new policy became Quantitative Easing and ZIRP or negative interest rate policy.

The end result to Quantitative easing under negative interest rates was a flat yield curve as longer dated bond yields dropped. The flattened yield curve became a threat to banks and financial institutions ability to lend for profit, hold long term financial instruments  and to Japan's GDP. Japan's GDP in 2014 was 0.37%, 2015 at 1.35, 2016 at 0.94 and 2017 reported 1.71. Years 2019 and 2020 were negative GDP.

As Quantitative easing and negative interest rates crashed and burned, the BOJ adopted QE under Yield Curve Control. Target interest rates shifted from 0 to short and long term rates. The BOJ question at this stage is where are rates in line with the 2% Inflation Target and is it possible to anchor Inflation above 2%. The Monetary Base would expand until Inflation and appropriate interest rate levels balance.

As Quantitative easing remains the first component to the BOJ's Monetary Policy, Monetary Base expansion would allow the BOJ to deviate from the Call Rate Target to a range of JGB maturity purchases  as well as ETF's and REITS. Reits are denoted as Real Estate.

The YCC target is the deposit rate at minus 0.1% or as an interest rate at 0.9. JGB's purchased at the 10 year yield based on the BOJ is referred as 0 but 0 is the bottom and purchases range from minus 0.5 and + 0.5 or 0.5 to 1.5. BOJ Monetary Policy statements amplify the JGB 10 year range and deposit rate in every policy statement. Most vital is the JGB 10 year yield range from minus 0.5 to + 0.5.

The current 10 year JGB yield opens the week at 0.426% or 1.426 and extremely close to the BOJ's 1.5 top. The BOJ contains a policy  obligation to intervene by conducting a FIX Rate purchase or sale to allow  a lower JGB in line to BOJ specified  ranges.

YCC as the main 2016 component to BOJ Monetary Policy is an enormous success as the JGB yield curve traveled from flat to a beautiful upward and positive slope from 3 month to 30 year yields.

The word tweak to BOJ and YCC policy lacks credibility spoken in the same sentence as no need exists for the BOJ to change or tweak the current policy as YCC works perfectly. The last Inflation report at 2.2% is the beginning to the testament of success.

JGB Yield Curve as demonstrated by first positions to JGB then as interest rates to show the Yield curve as an upward slope. Most vital is the second interest rate position.

The only BOJ change to JGB purchases was elimination of the 7 to 12 year yields. The BOJ is operating within the context from 3M to 10 year or a 59 point spread.

3m = -0.017 = 0.83.

2Y = -0.061 = 0.939.

3Y = -0.044 = 0.956.

5Y = 0.082  = 1.082.

10Y = 0.426 =  1.426.

15Y = 0.794 = 1.794.

20Y = 1.015 = 2.015.

30Y 1.26 = 2.26.

The BOJ issuance JGB plan for 2023 begins at Initial 198, 600.0 to FY 190,300.0 billion yen. The issuance plan includes JGB adjustments between Fiscal years, Rollovers and sales to Households. Issuance refers to offer JGB's at face value for auctions from June 2023 to March 2024 to cover Japan's Fiscal years from April to April.

YCC risks

The risks to YCC relate to the same questions the FED and Treasury adopted as YCC from 1942 to 1951. The BOJ deals with a 3M to 10 year spread at 59 points while the FED in 1942 capped rates from 0.038 to 2.5 or a spread at 2.42 points.

The FED opened a T Bill facility to purchase T Bills at 0.038 from banks and on demand while the BOJ allows the 3M Bill to free float. The Fed's T Bill Facility acted later as Excess Reserves.

Investors seek yield and profits and those profits are found at longer dated bonds rather than at 3M durations.

The imperative for the BOJ is to maintain YCC and yield control otherwise yields free float and the BOJ loses all controls. The 10 year JGB for example follows closely to the US 10 year. Current US 10 year at 3.76 Vs JGB 10 year at 1.42 is a great distance. How does the BOJ handle a rising US 10 year yield and at what cost to the Monetary Base and planned issuance schedules.

Not only the levels of interest rates are vital but ranges and volatility at each yield level.

Current BOJ lacks any need to touch or adjust Quantitative Easing or YCC as the policy has finally melded  together. No reason exists not to work in the future.

Risks to YCC = monetary base, money supply, USD 10 year yields.