A disorderly shift in Japan's monetary policy could spark bond-market contagion and increase risks of a 'financial accident,' Mohamed El-Erian says

• Japan needs to be mindful of its yield curve control exit, Mohamed El-Erian wrote in Bloomberg.
• A disorderly exit would create volatility in world markets, and add to risks of a
  "financial accident."
• But Japan needs to accelerate the phase-out, the top economist added.

Japan's central bank should be mindful of how it ends the country's yield curve control policy, as any mismanagement could roil global markets, economist Mohamed El-Erian wrote for Bloomberg.

The Bank of Japan has used YCC to keep yields at specific levels, putting it at odds with much more hawkish peers around world that have been aggressively hiking rates.

YCC has also caused extreme yen weak and other distortions that have raised doubts about central bankers' ability to execute a gradual phase-out.

But a disorderly exit shouldn't happen either, as it would be destabilizing for Japanese balance sheets, El-Erian wrote. In this scenario, Japanese investors would be forced to dispose of foreign corporate and sovereign bond positions.

"The resulting contagion would exacerbate the instability in global markets already contending with developments in the US Treasury segment. High volatility in two of the world's most-important sovereign bond markets would increase the risk of financial accidents and add to headwinds facing global growth," he wrote.

Despite this, the Bank of Japan should quicken its policy exit, as increasing distortions only add to the risk of a forced mishandling, El-Erian said.

Japanese authorities may be close to changing policy, as a recent Nikkei report hinted that government yields may be allowed to climb higher. Immediately after the report, the yen rallied 0.8% against the dollar.

Still, El-Erian cautioned that the longer external pressures for Japan persist, the greater the probability that foreign and domestic traders will test the central bank's ability to maintain its current monetary policy.

"The bigger the cracks that result, the higher the likelihood that a forced mishandling of this exit has negative spillbacks to the US and the world, amplifying bond-market volatility," he wrote