The author is senior economist and head of Japan FX Strategy at JPMorgan
It is not surprising that the market followed the old comments of Kazuo Ueda, the recently announced governor of the Bank of Japan. A relatively unknown academic outside Japan who served on the central bank’s board between 1998 and 2005, Ueda’s nomination has quickly become known to both the man and his profile.
But this is the risk of missing the forest for the trees. The question to ask is not who, but why. Why did the administration of Prime Minister Fumio Kishida nominate a comparative outsider to lead the BoJ, breaking the long-standing tradition of appointments from the Ministry of Finance and from the bank’s ranks?
Maybe other people don’t want to work. Or perhaps Ueda offers a shot at a relatively clean break for monetary policy. If the legacy of ultra-easy Abenomics looms large in Japan, unraveling its increasingly complex policies will require someone who is, at least, not an architect.
And this is probably the point. The central bank’s ultra-loose policy is now on a predetermined path – towards (if not quite through) the exit door. This scene is gaining traction in Tokyo. Faced with a decade-high national wage growth, increasing price pressures, and fueled by a dysfunctional bond market, the BoJ’s policy of pushing yields – known as yield curve control – is on its last legs.
It’s not just Ueda’s surprise announcement as governor that suggests more policy is on the horizon. A sharp shift in the portfolio of Japanese investors also glowed amber.
Japan sold bonds overseas at a record high last year, with Tokyo megabanks and insurance groups selling nearly ¥25tn ($186bn). If Japanese investors release foreign bonds equivalent to $180bn in one year, that is material: Japan is a net seller in the global debt market for two months in 2022.
The fast and furious pace of Japanese sales continued until the end of the year. Data released this month suggested that Japanese investors were net sellers in around 70 percent of major global bond markets in December, with the biggest outflows coming from the US, Europe and Australia.
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What explains Japan’s rush to release global debt? Expectations of higher foreign yields (and thus lower bond prices) and a sharp sell-off in the yen in 2022 will certainly play a role.
Japanese investors typically sell foreign bonds when the yen depreciates, when the cost of hedging foreign currency exposure rises, or when global yields rise. Last year was no different. But what has changed is the way Japan sells.
This is a sign that domestic investors are looking to step back from yield curve control. By liquidating foreign bond holdings, they keep the powder dry to prepare for better onshore yields. So, if the Ueda-led BoJ continues to normalize policy, last year’s sharp reorientation in Japan’s investment allocation could continue.
An inflection in these flows will have important long-term implications for global market liquidity. Most important is the steady rotation in the allocation of Japanese investors from overseas bonds back to domestic debt, as Japanese debt ultimately offers higher yields, and thus is more attractive.
How far should Japan’s government bond yield benchmark rise to ensure the country’s sell-off rate in global debt markets? Our estimates show that the current selling volume will be consistent with the yield on the mainland by more than 1 percent, or more than twice the level allowed by the BoJ today.
If we are correct in our opinion, according to Ueda’s watch, the BoJ will finally allow the increase in the yield benchmark to this level, the Japanese aircraft from the foreign market can accelerate. And the ongoing reorientation in Japan’s portfolio allocation will have important implications for those markets where Japan’s exposure is highest.
It is reasonable to assume this is most important for the US Treasury market, where Japan is the single largest foreign holder. To be sure, we will no longer deny that the spillover of any exit from the YCC can be reflected most imminently in the higher US yields.
But a longer-term pullback in Japanese flows could put pressure on other, smaller debt markets. Japanese investors hold market share in the single to high double digits in Australia, New Zealand and parts of western Europe. Ueda’s policy shift is not limited to Japan, but also to pockets of the global debt market.