Japan Signals End to G10 ‘Central Bank Put’: McGeever Reports

By Jamie McGeever

ORLANDO, Florida – The Bank of Japan’s recent decision to eliminate its hard yield ceiling of 1% marks a significant shift in the longstanding belief that central banks have a protective role in stabilizing financial markets—a notion often referred to as the "central bank put."

For years, investors operated under the assumption that the Federal Reserve and, subsequently, other central banks would intervene to ease credit and support faltering asset markets whenever declines threatened to escalate. This perspective, whether justified or not, became widespread since the tenure of former Fed Chair Alan Greenspan.

In the aftermath of the Great Financial Crisis, the distinction between maintaining financial stability and propping up asset markets became increasingly blurred. Historically, since Greenspan’s rise to the Fed chair in the late 1980s, central banks were primarily focused on combating deflation rather than inflation. Countries like Japan and Switzerland were heavily involved in this struggle.

However, as many economists assert, that world has shifted. Even Japan is now facing the challenge of managing inflation that exceeds target levels. This challenges the assumption that central banks will automatically loosen policy to support financial markets in tough times.

“Markets didn’t recognize that the ‘central bank put’ was a luxury that existed only when inflation was under control,” states Steven Englander, head of global G10 FX research at Standard Chartered. “It’s accurate to say that policies designed to enhance asset market resilience through liquidity have largely been reversed.”

The concept of central banks coming to the rescue of investors through interest rate cuts began during Greenspan’s leadership. Policymakers increasingly acknowledged that stock price fluctuations could influence consumer spending and overall economic growth. Research highlighted that since the mid-1990s, the Fed typically lowered rates by an average of 1.2 percentage points following a 10% drop in stock markets.

Over the years, interest rate movements have also shown asymmetry; the Fed’s rate hikes after market recoveries have generally been less aggressive than initial cuts.

As zero interest rate policies (ZIRP) emerged following the 2008 financial crisis, the notion of a central bank put expanded to include government bond purchases and currency management, as evidenced by the Swiss National Bank’s struggle to keep the Swiss franc from appreciating.

This effort culminated in 2015 when the SNB allowed the currency to float freely, resulting in significant volatility and a 30% revaluation.

Since the surge in inflation post-COVID-19, developed economies have distanced themselves further from such supportive monetary policies, implementing significant rate hikes and reducing balance sheets.

Japan, with its high public debt exceeding 250% of GDP and the Bank of Japan holding approximately half of the government bond market, was always expected to be the last to adapt. While the BOJ maintained its benchmark policy rate at -0.10%, the downgrading of the 1% yield cap on 10-year Japanese government bonds to a “reference” rate is noteworthy. The rapid decision to abandon the cap hints at a serious commitment from the BOJ under Governor Kazuo Ueda. Considering the BOJ anticipates inflation to surpass its 2% target next year, there is speculation about potential rate increases in the upcoming months.

However, such action may be premature, and challenges remain as the BOJ intervened in the bond market again recently. Policymakers need to be cautious about the impact that rising borrowing costs might have on Japanese banks, financial institutions, and businesses heavily reliant on years of easy money—often referred to as "zombie" firms.

As Marc Chandler of Bannockburn Global Forex emphasizes, the ultimate concern remains financial stability, which should be at the core of the central bank’s mandates. "There is a perception that the central bank put exists; however, it is largely misunderstood and primarily related to financial instability," Chandler notes.