According to analysis from Deutsche Bank AG, Japan may need to shift its future policy emphasis away from supporting the yen towards controlling government bond yields. This move is seen as necessary to reduce financing costs and ensure fiscal sustainability in order to achieve the government's ambitious economic growth targets.
Late last month, Japanese Prime Minister Sanae Takaichi unveiled a growth plan valued at approximately $2.3 trillion. In a recent report, Deutsche Bank AG strategist Mallika Sachdeva noted that this plan signifies Japan is at a critical juncture for a major transformation in its fiscal and industrial policies. The government must balance expanding fiscal spending with maintaining long-term fiscal health.
The growth strategy aims to fund the substantial fiscal outlays by mobilizing domestic savings and encouraging large institutional investors to increase their allocation to domestic assets. Simultaneously, Japan must ensure that its nominal economic growth rate consistently outpaces its financing costs to keep its debt burden manageable.
Sachdeva suggests that achieving these dual objectives may require the Japanese government to take measures to suppress government bond yields and control overall financing costs. This indicates a potential shift in policy priorities. For some time, the Japanese government and the Bank of Japan have focused on curbing yen depreciation, including multiple large-scale foreign exchange interventions, with limited effect.
The yen recently hit its lowest level in about 40 years before rebounding somewhat on reports that BOJ officials were willing to raise interest rates faster than markets anticipated. Sachdeva states that if enhancing fiscal capacity becomes the primary policy goal, Japan's future focus may shift from foreign exchange management to yield management—moving attention from the USD/JPY exchange rate to controlling 10-year government bond yields and overall borrowing costs.
Japan previously implemented a Yield Curve Control (YCC) policy from 2016 to 2024 to keep financing costs low. Similar policies have been used historically by other nations, such as the United States during World War II to finance war efforts.
Deutsche Bank AG points out that Japan is not the only developed economy facing high debt pressure while seeking to revitalize growth. However, with Japanese government debt exceeding 200% of GDP, its fiscal policy space is significantly more constrained than other major economies. Concerns over debt sustainability are already being reflected in the bond market.
This year, long-term Japanese government bond yields have been rising persistently, with the 30-year yield reaching a record high. Sachdeva anticipates that Japan is more likely to manage long-term yields by influencing bond demand in the future. One approach could involve directing the roughly $1.8 trillion Government Pension Investment Fund (GPIF) to increase its allocation to domestic assets, thereby boosting demand for Japanese government bonds.
Another possibility is for the Bank of Japan to reinstate or increase its support for the bond market through measures like resuming government bond purchases or maintaining a relatively accommodative monetary policy to help control yields. However, she notes that if the BOJ resumes bond buying or maintains loose policy, it could put downward pressure on the yen. Conversely, if the GPIF repatriates some of its overseas assets back to Japan, it could provide support for the yen.
Sachdeva concludes that as Japan works to suppress volatility in government bond yields, volatility in the foreign exchange market may also intensify in the coming period.
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