Japan's central bank "raids" the global market: the bond market is in a state of mourning, and emerging market currencies have given back more than half of this week's gains.

Today, the subtle change in wording from the Bank of Japan has caused turbulence in the bond and foreign exchange markets.

After the announcement by the Bank of Japan, the yield on 10-year Japanese government bonds soared to 0.572%, reaching a nine-year high. The yen appreciated by 1.2%, reaching a high of 138.05 yen against the US dollar, but later gave back most of its gains, trading at 140.51 yen against the US dollar.

In addition, the signs of a policy reversal by the Bank of Japan also indicate that the Japanese banking industry may recover lending profits. Today, Japanese bank stocks surged by 4.6%, reaching an eight-year high.

In overseas markets, benchmark bonds in many countries experienced a sharp decline. The yield on Australian 10-year government bonds rose by 14 basis points, and the yield on Korean bonds maturing in 2033 climbed 10 basis points to 3.76%, the highest since March. The yield on South African rand bonds maturing in 2035 rose by 11 basis points, the highest in two weeks.

The potential for a stronger yen has diminished the attractiveness of interest rate differential trades in the foreign exchange market, causing most emerging market currencies involved in such trades to decline. The MSCI Emerging Markets Currency Index fell by as much as 0.4%, erasing more than half of this week's gains, with Asian currencies leading the decline.

For many years, the Bank of Japan's ultra-loose monetary policy has made the yen the main source of funding for carry trades. Currency market investors typically choose to borrow cheap yen to invest in high-yielding assets in emerging market countries with high inflation.

Moreover, since 1992, Japan has consistently been the world's largest creditor nation, with the United States, France, and the United Kingdom being its top three debtor nations. In addition, Japanese funds have made significant investments in European power plants, high-risk loans, and other sectors.

Surprise Move by the Bank of Japan

Today, the Bank of Japan announced that it would maintain the target range for 10-year Japanese government bond yields at ±0.5%, but stated that it would flexibly control the yield on 10-year government bonds. The central bank also announced that it would purchase 10-year government bonds at a yield of 1% on each business day, instead of the previous 0.5%.

This move has been interpreted by the market as a plan by the Bank of Japan to reverse its loose policy that has been in place since 1999. Market participants widely believe that the hawkish tone of the Bank of Japan indicates that the institution may tighten monetary policy to address inflation, similar to other major central banks.

Since the beginning of this century, the Bank of Japan has implemented a series of unconventional and ultra-loose monetary policies, especially under the promotion of "Abenomics" since 2013. Among the major economies in the world, Japan is currently the only major economy that still maintains negative interest rates and controls long-term government bond yields through yield curve control.

Therefore, any movement in the Bank of Japan's policy will have a significant impact on global financial markets. If the Bank of Japan truly abandons its Yield Curve Control (YCC) policy, causing the yen to enter an upward trend and leading to the repatriation of Japanese household assets, it would be nothing short of a financial earthquake. UBP's senior Asian economist in Hong Kong, Carlos Casanova, commented:

Despite the Bank of Japan maintaining the upper limit of 'around 0.50%', subtle changes in wording indicate that they are preparing, or at least open to adjusting the YCC target on a future date, provided that conditions are favorable.

Tom Nash, portfolio manager at UBS Asset Management Australia, believes that the Bank of Japan has taken a "significant step towards eventually dissolving YCC."