[Song Seungseop's Financial Light] Japan's Long-Term Government Bonds Sold 4 Trillion Yen in One Week

Japan Bank's YCC Stubbornly Maintained for Years
Bond Sales and Purchases to Reach Desired Target Rate
YCC Changed After 21 Months... "Interest Rate Hike"
Value Dropping... Overseas Investors 'Selling'

Editor's NoteFinance is difficult. It is filled with confusing terms and complex backstories. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even if you know nothing about finance, you can immediately understand these 'light' stories that turn on the bright 'light' of finance for you.

[Image source=Reuters Yonhap News]

[Asia Economy Sejong=Reporter Song Seungseop] The Bank of Japan (BOJ) purchased an enormous amount of government bonds last year. Overseas investors suddenly sold off Japanese bonds at the end of the year. Both indicators reached their highest levels in years. Behind this is the 'Yield Curve Control (YCC)' policy.

The central bank is the institution that controls a country's interest rates. To do this, it buys and sells bonds. When the central bank buys a lot of bonds, money flows into the market, increasing liquidity and lowering interest rates. Conversely, when it sells bonds, money in the market is absorbed by the central bank, causing interest rates to rise. This is called open market operations.

Buying and Selling Bonds Until Desired Interest Rates Are Achieved

YCC is a policy where the central bank sets a target for long-term interest rates and buys or sells bonds to achieve it. Unlike quantitative easing, which indiscriminately purchases various assets, YCC focuses on specific products. For example, if the central bank wants to set the 20-year government bond yield at 5%, but it is currently around 3%, it buys that particular bond. There is no set limit on how much to buy. The characteristic of YCC is that it continues buying until the target is reached.

The name 'Yield Curve Control' comes from the nature of bonds. The yield curve shows how bond yields vary depending on maturity. Shorter-term bonds have lower interest rates, while longer-term bonds have higher rates. It makes sense to receive higher interest for lending money longer. However, the rate at which interest rises slows as maturity lengthens. Whether the maturity is 100 years or 110 years, the interest rate does not increase much because the maturity is extremely long. Therefore, the yield curve is an upward-sloping curve that becomes flatter as maturity lengthens.

Japan is a representative country operating YCC. The BOJ has been implementing YCC since September 2016. Specifically, its goal is to keep the 10-year government bond yield at 0% ± 0.25%. If the yield moves outside the -0.25% to 0.25% range, the BOJ buys or sells bonds to bring it back within this range.

Why did Japan start this policy? At that time, Japan introduced a negative interest rate policy to stimulate the economy. Consequently, government bond yields plummeted. While companies benefited from borrowing money cheaply, banks and insurance companies that create products based on interest rates faced serious difficulties. Especially when long-term government bond yields fell into negative territory, the BOJ began controlling the yield curve to prevent side effects.

BOJ Finally Raises Rates... Investors Sell Japanese Government Bonds

Haruhiko Kuroda, Governor of the Bank of Japan (BOJ)
[Photo by Yonhap News]

However, on the 20th of last month, the BOJ changed its policy for the first time in 21 months. It widened the target range from 0% ± 0.25% to 0% ± 0.50%. This broke the expectations of experts and investors who predicted YCC would continue unchanged, producing the exact opposite result.

This move effectively means an increase in Japanese interest rates. While major advanced countries have been raising rates to curb inflation, Japan maintained very low rates through YCC. But with the change, rates can now rise up to 0.50%.

The BOJ explained the policy change as a measure to 'strengthen the sustainability of monetary easing.' However, experts also analyze that it was an unavoidable decision. As the U.S. continues to raise rates, Japan could not avoid following suit. Holding out longer and raising rates later might have caused a bigger shock to the Japanese market.

There is speculation that this move could mark a turning point in Japan's ultra-low interest rate policy. JP Morgan described this action as "a short-term strengthening factor for the yen, as it is the first sign that the BOJ is moving away from its easing stance."

How did investors holding Japanese government bonds react? After the YCC-related announcement, the 10-year Japanese government bond yield surged rapidly from 0.25% to a high of 0.444%. When bond yields rise, bond prices fall. Foreign investors, anticipating a drop in the price of Japanese long-term government bonds they held, sold 4.8623 trillion yen (approximately 46.6343 trillion won) worth of bonds between the 18th and 24th of last month. This is the largest scale since 2014.