Explained for everyone to understand in under 5 minutes:

Last week, the Bank of Japan (BOJ) made two significant decisions that caught the attention of the financial world. First, they decided to maintain the interest rate at -0.1%, even though inflation in Japan is on the rise. Second, they urgently decided to purchase 5- and 10-year government bonds worth 3 billion dollars to keep the yield on the 10-year bond below 0.65%. This essentially means they are printing money, causing the Japanese Yen to weaken (which is good in the short term, as long as a significant crash doesn’t occur) and leading to future inflation and a rise in interest rates, resulting in a stronger Yen (which is negative).

This move to keep the 10-year bond under control at a maximum threshold of 0.5% is called Yield Curve Control (YCC). BOJ chose this control regime because they had reached the limit of quantitative easing, where they bought targeted amounts of bonds to reduce yields, hoping to stimulate inflation and economic activity without exceeding their inflation target of 1.9% to 2%.

The problem is that YCC worked well when inflation was low, and the prospects of BOJ achieving its price target were weak because investors could sit on a pile of government debt that offered secure yields.

This changed last year when commodity prices surged, pushing inflation beyond the 2% target and giving investors reasons to challenge the yield limit. BOJ stepped up its purchases, including offers to buy an unlimited amount of bonds to defend the 0.5% yield limit. After BOJ purchased 3 billion dollars in bonds last week to keep the 10-year bond below 0.5%, it rose again above the target, hitting 0.65% today, sending a clear signal that this control is no longer sustainable in the long term, meaning interest rates must rise, leading to a stronger Yen.

Why does it matter to the markets in the US and Europe? The biggest concern is that Japanese investors, who hold a significant amount of US fixed financial instruments, including Treasury bonds and other securities, may start to see higher yields in their own market. This could trigger a massive liquidation of these US positions as investors repatriate assets to reinvest at home. This is already reflected in the yield of US 10-year bonds, which surpassed the 4% threshold yesterday. Rising US bond yields pose a systemic risk to US stocks and exchanges as investors consider the opportunity to cash out profits to invest in bonds with yields over 4%. Much love.