The precursor to yield control
Haruhiko Kuroda, governor of the Bank of Japan, shared one thing the bank experienced with its QQE (quantitative and qualitative monetary easing) program. Along with the negative interest rate policy introduced in January 2016, the bank was able to push down the yield curve in its entirety.
He noted that nominal interest rates have trended downward since the introduction of QQE. The pace of this decline gained momentum with the introduction of negative interest rates. The impact was felt the most by longer-maturity JGBs (Japanese Government Bonds). The graphs that he showed as proof of this are reproduced below.
Giving rise to the new policy framework
The impact that QQE and the negative interest rate decision had on the JGB yield curve formed the basis of the new policy framework. The impact gave rise to the thought that since bond buying and negative interest rates can help control the yield curve, they can be used to maintain the yield curve at a level that’s “deemed most appropriate” for achieving the inflation target of 2%.
Inflation and inflation expectations are key indicators looked at by fixed-income (BND) (AGG) market participants. If inflation expectations are rising, bond yields tend to follow, since they need to keep pace with a rise in the general price level. On the other hand, if inflation expectations are low, bond yields remain low as well.
The rise in yields feeds into the financial system, as loan rates are determined by yields on benchmark bonds. For instance, the ten-year bond yield in the United States (IEF) is used as a reference for setting interest rates for medium-term loans. Higher rates provide better interest income to banks (MFG) (MTU).
By controlling the yield, the Bank of Japan is trying to give rise to a view that it’s determined to get inflation to its target level and indirectly help inflation expectations rise.
The last point that Kuroda made about the comprehensive assessment of QQE was the impact of monetary easing on the functioning of financial intermediation. Let’s look at that in the next part.