Central Bank Tightening, International Version

by | Dec 21, 2022 | Blog, Bonds

Bank of Japan (BOJ) Finally Flinched


BOJ made a decision to double the trading band of the 10-year Japanese government bond. We believe the move is justified. It may mark the start of a gradual shift away from the strict bond yield controls emblematic of Japan’s status as the last big economy sticking to ultra low rates. 

Tuesday’s move is too little, too late. It comes six years after the BOJ adopted negative interest rates. It is the boldest step BOJ Governor Haruhiko Kuroda has taken, after enduring after years of criticism — and only when he has one foot out of the door. Even after spiking, the yen remains at a two-decade low to the dollar.


Source: Bianco. As of 12/20/22.


The BOJ’s move was what they called a “technical adjustment” due to financial stability issues, but we believe the real reason this move was necessary is that inflation is running way ahead of their target and forcing yields higher.

Now that Japan has joined the inflation fight, it makes the idea of a “pivot” by other central banks less likely. Inflation may have peaked, but getting it back to countries’ 2% target is going to be difficult, even in Japan.


Europe Has a Big Problem


Inflation in the Eurozone is still at 10%, and the European Central Bank (ECB) is an inflation-only mandated central bank (i.e., unlike the Fed, it has no direct employment mandate). Therefore, it’s not surprising that the ECB is communicating the need for ongoing rate hikes “at a steady pace” and to a “significantly” higher level. 

In fact in real terms, given where short-run inflation expectations are today, ECB policy is easier today than it was before rate hikes started. Most likely, the ECB will hike more than the 75-100 bps additional tightening that the market is pricing in.


Source: Piper. As of 12/20/22.


The key sentence in the ECB statement last week was the following: “the Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target.” The qualifier “significantly” tells us that the peak rate is still far off; the phrase “at a steady pace” suggests more consecutive 50-bp hikes. Continued tightening should continue to be a tailwind for the Euro.


Will the Sub 3.5% Terminal Rate Be Enough for the ECB Given 10% Inflation?


The chart below shows, as of today, the market expects the ECB to hike less than 100 bps more from current levels — we think that is not going to be enough. The verbiage about more hikes “at a steady pace”, to a “significantly” higher level, suggests that the peak rate will be higher than the market expects and that the ECB will pause after the Fed does. 

The market also expects prompt rate cuts after the peak is reached. That is also something that the ECB is unlikely to do. We need to remember again that the ECB is a single-mandate central bank focused only on inflation; given how high inflation is, the ECB will want to be really sure that inflation has been defeated before cutting rates, and that will take time.


Source: Piper. As of 12/20/22


Yields Ex- US Continue to Drive Higher


Rates globally continue to push higher following central bank rate hikes. The actions by the BOJ (raising the cap on their Yield Curve Control) serve to raise the floor on U.S. yields for the short / medium term. Again, this validates our opinion that we are nowhere close to the elusive Fed Pivot. 


Source: Strategas. As of 12/20/22.


Happy Holidays & Happy New Year! Thank you for the trust and support and we look forward to another year (hopefully with a more friendly market)!




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