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Did Bank of Japan Kill The JGB Market?

By  |  Bonds  |  Nov 06, 2013 06:58AM GMT  |   Add a Comment
 
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“The JGB market is dead,” announced with finality Tetsuya Miura, chief bond strategist at Mizuho Securities, one of Japan’s 23 primary dealers that have to bid on Japanese government securities at auctions. Only the Bank of Japan, and nothing else, was still “driving bond prices,” he said.

The BOJ is on a crusade. No central bank of a developed country is more reckless, not even the Fed. It started with a recurring mis-definition. "The biggest challenge facing Japan's economy is to overcome deflation," reiterated BOJ Governor Haruhiko Kuroda on Tuesday. Mis-definition because over the last 15 years, mild inflation was interrupted by mild deflation for a minuscule net deflation. The Japanese were simply spared the painful procedure of having their wages and assets hollowed out by inflation. No, Japan’s “biggest challenge” is its relentless, out-of-whack budget deficit year after year, where nearly half – and sometimes over half – of all expenditures are borrowed. That stimulus program, the largest in the developed world, has become the most insurmountable mountain of debt.

So starting on April 1, the beginning of the fiscal year, the BOJ embarked on a money printing campaign without precedent in the developed world, printing ¥7 trillion per month, as Kuroda told leaders of Japan Inc. in Osaka on Tuesday, to achieve “2% price stability" – an insider joke he keeps playing on Japanese workers, whose wages are not keeping up with it, and on holders of JGBs, CDs, and similar near-zero yielding instruments that are now turning into Swiss cheese.

Between April 1 and October 31, the monetary base has jumped 32%, in line with Kuroda’s promise to double it in two years and water down the yen through "massive purchases" of JGBs of all maturities. He pointed out proudly that this has "been progressing ... as scheduled." So in just seven months, government securities on the BOJ’s balance sheet have soared 40% to ¥175.6 trillion. The marks of a central bank in full bloom. Even if it did not help the real economy, it was very successful in other aspects.

It caused asset bubbles. It drove up annual inflation in September to 1.1% (with prices of goods jumping 2.1%!). It pushed down yields, with the 10-year JGB yield now at 0.6%, the lowest in the world though this crappy paper has been cut three notches below triple-A.

And it killed the market for JGBs.

Average Monthly Trading volume among large financial institutions has collapsed to ¥37.9 trillion last quarter, the lowest in the data series of the Japan Securities Dealers Association, dating back to 2004. That’s down 61% from last year's monthly average of ¥98 trillion. JGBs have become unresponsive to fiscal risks, inflation, the economy, or anything else. Liquidity has evaporated. Pricing has become meaningless.

After declaring that the JGB market was dead, Tetsuya Miura pointed out ominously, according to Bloomberg, that these low yields were responsible “for the lack of fiscal reform in the face of Japan’s worsening finances. Policy makers think they can keep borrowing without problems.”

They did pass the consumption tax hike from 5% to 8%, effective April 1. It will bring in new revenues. It’s already causing a tsunami of purchases as consumers and businesses are frontloading major items – which will leave behind a hole after the hike takes effect. Japan has been through this before. So the government unveiled a ¥5 trillion stimulus package to counteract the negative impact of the tax hike. While consumers pay more for nearly everything, the package hands a variety of goodies to Japan Inc.

Japan does have some of the highest corporate income tax rates in the world – but like in the US, there are deductions, loopholes, and tax avoidance strategies, so only 30% of all companies, according to Finance Minister Taro Aso, actually pay any corporate income tax at all. As of April 1, their tax burden will be even lower – another hallmark of the fiscally most irresponsible country in the developed world.

But Mizuho’s Miura wasn’t the only one lamenting the death of the JGB market, and the severing of the link between it and economic fundamentals.

Takatoshi Kato, former top currency official at the Ministry of Finance and current president of Japan’s Center for International Finance, explained that the BOJ was willing “to sacrifice liquidity and trading volumes in the bond market” in order to pump up inflation price stability.

“To all intents and purposes, there is no JGB market,” Nicholas Spiro, managing director of Spiro Sovereign Strategy in London, told Bloomberg.

“Market functions are sacrificed for the sake of ending deflation,” echoed Izuru Kato, president of Totan, the research arm of money-market broker Tokyo Tanshi. And he warned that tapering monetary stimulus could drive down bond prices and drive up yields, which would cause a host of problems.

If yields rise by 1 percentage point, according to Japan’s Financial System Report, it would cause ¥8 trillion in losses across the banking system. Banks would be able to digest it; the system is safe. But then, tucked away from sight, the report tallied up the losses of a 3 percentage point rise.


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