SSGA: What is the road ahead for investors in Japan?

August 24, 2023

The Bank of Japan has relaxed its yield control policy, allowing more leeway for Japan’s bond yields. Simona Mocuta, Chief Economist at State Street Global Advisors discusses what this means for Japan’s monetary policy going forward and its implications for global investors. According to Mocuta, the path towards normalization is fraught with at risks related to market functioning and to tapering.

With the BoJ relaxing the 10-year JGB yield band, the next leg of their policy normalization journey may have begun. Fundamentally, we expect the Japanese economy to continue to grow at a solid pace with a virtuous cycle between higher prices and wages taking shape. Additionally, the chances of a hard landing have diminished in the US and inflation is declining, which may allow the 10-year JGB yield to find its fair value at around 0.75%.

If this narrative plays out, we expect the BoJ to change the structure of YCC by targeting the 10-year JGB yield at 0.5% with a 50 bp/100 bp tolerance band by Q1 2024. This may mean that yields may remain in the same range or may move slightly higher. We still think that an outright removal of the YCC policy is improbable, given the policy’s centrality in managing Japan’s high government debt (258.9% of GDP in 2022).

If the Japanese and global economies are able to endure what could be a seismic shift in BoJ’s monetary stance, we expect the BoJ to move out of its negative interest rate policy and raise the benchmark short-term interest rate to 0.0% by H2 2024. For this to happen, the central bank would like confirmation of strong wage growth from next year’s shunto negotiations as well. Regardless, the path towards normalization is fraught with at least two key risks:

1. Risks related to market functioning
2. Risks related to tapering

Clearly, the BoJ has its task cut out with regard to policy normalization, having to deal with not so insignificant market risks detailed above. To be sure, the key lies in adopting a measured approach, which should ensure that global market volatility is under control. Finally, risks of a recession have declined but not disappeared in Japan. If a recession were to materialize, the normalization process will stall and will be pushed forward to a more salubrious period.