Last year we have talked quite a lot about BOJ and the unsustainable balance sheet it holds. Now, with the rising yield pushed by FRB, the BOJ has to face a substantially worse situation as it has increasingly little room for monetary policy while the prospect of economy and inflation are still in gloom. I will continuously gather the relevant articles in this blog.
Large hedge fund managers like Kyle Bass or Crispin Odeywere have been shorting JGBs for a while. After all, it was an awfully compelling story. It’s difficult to see how Japan will be able to manage its monster debt load without inflating it away.
Yet the great global bond rally of 2016 that drove European sovereign yields to batshit crazy negative levels, dragged Japanese government bonds along. -> One of the most overindebted countries in the history of modern finance trading with a 0% thirty year bond.
-> Then a crazy thing happened. Worried its bonds would trade at negative yields and pressure the financial system, the Bank of Japan pegged its 10 year yield at 0%. -> In doing so, the BOJ moved from a set rate of balance sheet expansion to one that varies based on whether that peg is either too high, or too low. -> If the equilibrium level of 10 year rates was in fact below 0%, the Bank of Japan would be forced to sell bonds to keep rates stuck at 0%. If there was demand for credit and 10 year rates moved higher, then the BoJ would be forced to buy bonds to keep them from declining. -> at its heart, the BoJ was giving up control of its balance sheet so it could peg a specific part of the yield curve.
(Of course Central Banks do this all the time. The difference is they usually operate at the front part of the curve, and when there is too much demand or supply, they change the rate.)
-> The Bank of Japan had not eliminated volatility, but merely postponed it.
–>> An expansionary feedback loop: Eventually the Bank of Japan’s massive balance sheet expansion would kick in. At that point, inflation would pick up, credit would be demanded (?) and the BOJ would be forced to defend the 0% peg -> be forced to buy an unlimited number of bonds at a level below the market and expand the amount of base money, which if not offset with a decline in the velocity of money, would create more inflation, etc… All of this would be occurring with an already highly supercharged Japanese Central Bank balance sheet.
BoJ was tested by the market last week as the JGB 10 Year bond spiked through the previous high yield on news the BOJ would not be expanding their balance sheet quite as aggressively as expected in their regular QE program.
(“Market looks to have been looking for a broader spectrum of purchase increases to reaffirm the commitment”)
- The short-term policy rate, which applies to some bank reserves, was held at -0.1 percent.
- The long-term policy rate, which is a target applied the yield on 10-year Japanese government bonds, was left unchanged at around 0 percent.
- The inflation forecast for the fiscal year starting on April 1 was kept at 1.5 percent.
- The GDP projection for the fiscal year was raised to 1.5 percent, from 1.3 percent.
As yields popped through the previous 0.10% yield ceiling, the Bank of Japan came charging into the market. <- The BoJ bid 3-4 basis points through the market with unlimited size to push yields back down to the 0.10% level. (Many analysts interpret the BOJ’s target of around zero percent to mean a range between positive and negative 0.1 percent.)
–>> The market is finally saying the demand for credit is enough to force the Bank of Japan to buy bonds to keep rates down. And that was the signal of shorting JGBs.
+ BOJ faces the challenge of seeking to hold down borrowing costs just as accelerating inflation and an improving outlook for some of the world’s biggest economies push up bond yields globally.
(putting upward pressure on Japanese yields while also pushing down the yen. -> Further weakness in the currency, which would support exporters and help the central bank toward its distant inflation goal [A weak yen helps to boost exports and corporate profits, which should also encourage more investment and wage growth, though these flow-on effects have been disappointing so far.], may also raise the ire of Donald Trump and provoke a protectionist response that Japan can ill afford)
(However, It would be just like the Market Gods to finally usher in the JGBs collapse once all the hedge fund guys had given up on it…)
Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. are on course to exceed their fiscal-year profit goals, having all beaten analysts’ estimates for third-quarter earnings. Surging global bond yields and market volatility since Trump’s November election victory have been a boon to the banks’ fixed-income trading, helping to offset weak lending profitability, the results showed. And bank executives have welcomed Trump’s moves to relax financial regulations in the U.S., where the three firms have operations.
(Bond and securities trading profit jumped and credit-related costs fell)
Other tailwinds include a weaker yen, which has fueled inflation expectations (weaker yen inflating earnings abroad) and prompted economists to predict that the BOJ’s monetary easing is over.
“A year ago the outlook was for continually lower rates, whereas now we’re starting to see prospects of higher rates going forward”
(However, Domestic interest margins remain tight, interest rates are low or negative and competition is fierce,” “Japan’s megabanks still face a tough environment.”)
The BOJ holds more than 40 percent of Japanese government bonds, and the central bank’s stake continues to rise and rise.
As the central bank’s need to control yields drives unprecedented purchases of benchmark 10-year debt -> exacerbating concerns it will run out of willing sellers to supply it with bonds to buy.
“The BOJ actually decreased the pace of purchases late last year, but after the market started to price in the risks to drive the yield up to 0.15 percent, and forced the central bank to accelerate again”
-> The yen rallied after the increased operations showcased concerns the BOJ’s shift to targeting the yield curve hasn’t removed questions about the durability of its quantitative easing.
BOJ is also aimed at steepening the yield curve:
With Japanese investors selling off Treasuries at the fastest pace since 2013, it also raises the likelihood of pension funds and life insurers, which need long-term assets to meet similar liabilities, being drawn back to so-called superlong bonds — worsening the BOJ’s potential supply constraint
+ raising stimulus-sustainability issues: banks are seen getting closer to their target limits when it comes to selling down JGB holdings. (Japan’s banks sold 141 trillion yen of government debt in the first 3 1/2 years of Kuroda’s easing, playing a key role in supplying the 298 trillion yen that the BOJ bought in the same period. Banks have just 219 trillion yen of the securities left, and they need to keep some of that to meet regulatory requirements. That all adds up to the real possibility that the BOJ will face constraints on its capacity to buy bonds.)
And almost a third of the bonds it owns have no income — or just pay it 0.1 percent a year in interest.
-> surge in bond prices over the past four years could still create losses for the BOJ, because most of the debt it buys costs well above face value, even though face value is what the central bank will get back, because it plans on holding the securities to maturity. The looming balance sheet shortfall that creates is another of the concerns surrounding the long-term sustainability of the policy.
Looking forward, it seems the BOJ can’t stop buying, otherwise it would lose control of yields while its inflation target remains far from 2 percent. Yet it can’t go on buying forever either, thanks to a lack of ready sellers.