Policy Normalization Bets Reach Japan as Rates Turn Zero

(Bloomberg) -- Speculation of monetary policy normalization has reached Japan.

Two-year overnight-indexed yen swaps this week breached zero for the first time since 2016 -- the year the Bank of Japan introduced its negative interest rate policy. The sometime proxy for investor expectations of future policy rates has risen three basis points this year.

Meanwhile, the benchmark 10-year yield has climbed toward the upper end of the BOJ's desired trading band amid the global bond selloff -- fanning bets the central bank may step in to limit further gains.

While Japan remains an outlier in monetary policy and nowhere near peers like the Federal Reserve in unwinding stimulus, the nation's bond traders are dealing with speculation the BOJ will at least start to rethink its policy mix of curve control and negative interest rates. Governor Haruhiko Kuroda has repeatedly quashed such views, but his term will end in April 2023.

That has spurred chatter on a blank slate for his successor and the potential for rates to become more indicative of where policy might go.

“Market participants see an increasing chance that a successor to Kuroda will lift the negative-rate policy,” said Takahide Kiuchi, executive economist at the Nomura Research Institute in Tokyo. “As the end of his tenure gets closer, the governor's influence will decrease further.”

It's too early to raise interest rates or change the yield curve control program now, Kuroda said last week, just hours after the International Monetary Fund recommended shortening the maturity of its yield target. Deputy Governor Masazumi Wakatabe said Thursday as well that it's wrong to assume the BOJ will start to back away from stimulus any time soon, even if other central bankers are turning in that direction.

Japan's core inflation was at 0.5% in December, well below the central bank's 2% target and consistent with views that the BOJ will maintain its accommodative policy stance.

An auction of 30-year debt on Thursday drew a higher-than-estimated cut-off price, suggesting persistent demand for dip-buying.

“The recent rise in the 10-year JGB yield may have gone too far,” Tomonobu Yamashita and Shusuke Yamada, strategists at Bank of America, wrote in a research note. “Given the BOJ's dovish stance and leeway for increasing its JGB purchases, this may be an opportunity to buy JGBs cheaply.”