The writer is senior economist and head of Japan FX Strategy at JPMorgan
It is little wonder that markets were scouring decade-old comments by Kazuo Ueda, the newly announced Bank of Japan governor. A relatively unknown academic outside of Japan who served on the central bank’s board between 1998 and 2005, Ueda’s nomination has prompted a rush to understand both the person and his profile.
But this risks missing the forest for the trees. The question to ask is not who, but rather why. Why has the administration of Prime Minister Fumio Kishida nominated a comparative outsider to lead the BoJ, breaking with a long-held tradition of rotating between appointments from the Ministry of Finance and from within the ranks of the bank itself?
Perhaps others did not want the job. 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, dismantling an increasingly convoluted patchwork of policies will require someone who, at the very least, was not their architect.
And this is probably the point. The central bank’s ultra-loose policy is now on a somewhat pre-determined path — towards (if not quite through) the exit door. This view is gaining traction in Tokyo. In the face of decade-high national wage growth, broadening price pressures, and hastened by a dysfunctional bond market, the BoJ’s policy of seeking to cap yields — known as yield curve control — is on its last legs.
It is not just the surprise announcement of Ueda as governor that points to more policy lurches on the horizon. Sharp shifts in Japanese investor portfolios are also flashing amber.
Japan sold overseas bonds at a record pace last year, with Tokyo’s megabanks and insurance groups the drivers of close to ¥25tn ($186bn) in sales. That Japanese investors offloaded the equivalent of about $180bn of foreign bonds in a single year is itself material: Japan was a net seller in global debt markets in all but two months in 2022.
The fast and furious pace of Japanese selling continued through year-end. Data released this month suggested that Japanese investors were net sellers in about 70 per cent of major global bond markets in December, with the largest outflows coming from the US, Europe and Australia.
What explains Japan’s rush to shed global debt? Expectations of higher-still foreign yields (and thus lower bond prices) and 2022’s sharp sell-off in the yen have, of course, played a part.
Japanese investors have typically sold foreign bonds when the yen depreciated, when costs to hedge their foreign currency exposure rose, or when global yields were on an uptrend. Last year was no different. But what has changed is the sheer pace of Japanese selling.
That is a sign that domestic investors are eyeing a retreat from yield curve control. By liquidating their holdings of foreign bonds, they are keeping their powder dry in preparation for more attractive higher onshore yields. And so, if an Ueda-led BoJ continues to normalise policy, last year’s sharp reorientation in Japanese investment allocations could persist.
Such an inflection in flows will have important longer-term implications for global market liquidity. The most significant of these is a sustained rotation in Japanese investor allocations from overseas bonds back to domestic debt, as Japanese debt eventually offers higher, and thus more attractive, yields.
How far would benchmark Japanese government bond yields need to rise to warrant the furious pace of the country’s selling in global debt markets? Our estimates suggest that the current volume of selling would be consistent with onshore yields well above 1 per cent, or more than double the rate permitted by the BoJ at present.
If we are correct in judging that, under Ueda’s watch, the BoJ will eventually tolerate a rise in benchmark yields towards this level, Japanese flight from foreign markets may accelerate. And a sustained reorientation in Japan’s portfolio allocations will have important implications for those markets where Japanese exposure is highest.
It is tempting to assume this is most significant for the US Treasury market, where Japan is the largest single foreign holder. To be sure, we would not push back against the view that the spillover from any disorderly exit from YCC could be most imminently reflected in higher US yields.
But a longer-term retreat in Japanese flows could put pressure on other, smaller debt markets. Japanese investors hold market shares in the high-single to low-double digits in Australia, New Zealand and parts of western Europe. A shift in policy under Ueda will matter not just for Japan, but for pockets of global debt markets, too.