Markets Take Wild Ride As BoJ's Unexpected Policy Tweak Leads To Volatility: What Happened?

Global markets experienced a dramatic increase in volatility in the last hours of trading in New York on Thursday followed by a gradual reversal, resulting in a fresh bullish session for both equities and bonds on Friday. But what does the Bank of Japan have to do with all of this?

The wild market fluctuations started around 1 p.m. ET on Thursday, when Nikkei Asia reported the Bank of Japan was ready to tweak its yield curve control (YCC) policy. The yield on the Japanese 10-year bond is set at zero under this policy, with variations allowed within 0.5%. A change in policy from the Bank of Japan, one of the few remaining major central banks with negative interest rates, could have a significant impact on markets. 

Markets React Negatively To BoJ Policy Change Rumors

The Japanese yen immediately rallied against the U.S. dollar, with the USD/JPY exchange rate falling by more than 1%. Global bond yields increased and the 10-year Treasury yield jumped by 15 basis points, the most in a single day this year.

Risk aversion soared and global stock markets declined significantly. The S&P 500 index fell 0.7%, as did the Dow Jones Industrial Average, snapping a 13-session winning streak that has only occurred once since the postwar era (in 1987). The tech-heavy Nasdaq 100 index, as tracked by the Invesco QQQ Trust QQQ fell 0.3%.

The VIX fear index increased 9.3%, its highest daily increase since May 4.

What Did The BoJ Decide, And How Did Markets React?

The BoJ unanimously voted to retain its benchmark short-term interest rate at -0.1% and 10-year bond yields around zero. The board said the 0.5% yield movement ceiling was now a reference point rather than a hard cap.

This change makes the yield curve control policy more flexible, in line with efforts to strengthen the policy sustainability.

It’s worth noting that this isn’t a significant movement in the BoJ’s monetary stance; rather, it shows an adjustment toward greater flexibility.

Following this statement, the market fluctuations that had defined Thursday’s trading session reversed. The yen fell against the dollar, the sell-off in Treasuries ceased and stock markets rose once again.

Chart: Market Price Action On Thursday, Friday

Analysts Weigh In On BoJ’s Move

“They’ve changed the YCC without committing to too much and want to be more flexible about how they run monetary policy. We’re really at the beginning of the end of really extreme monetary accommodation, but they still sound very cognizant of the fact that there’s still downside risk to the economy and inflation outlook,” said Sally Auld, chief investment officer at JB Were, Sydney.

“The BOJ is in a difficult position” as inflation is running hotter-than-predicted, according to Chua Soon Hock, chief investment officer of Asia Genesis Asset Management, Singapore. “However, due to fears of a sudden spike in JGB rates, the BOJ is adopting a gradual and cautious approach to lifting rates, likely from here onwards,” the expert said.

LPL Financial’s Quincy Krosby said: “Despite the so-called ‘Shock and Awe’ move engineered by the BOJ overnight, Treasury yields have inched lower, particularly the ten-year yield, which galloped higher as news filtered out that an important monetary adjustment by the BOJ was going to be announced at yesterday’s meeting.”

The BoJ’s move is an “important step towards eventual disbandment,” said Tom Nash, portfolio manager at UBS Asset Management, Sydney.

“I expect yields will gravitate towards 1% but not get there in a straight line as you’re likely to get short covering, domestic buying, and the BOJ leaning against it.”

Read now: PCE Report Signals Easing Inflation: Top Wall Street Economists Weigh In On Market Implications