The Bank of Japan has endgamed itself

by Shaun Richards

This week is one where the main news is coming from the East and the Orient. Indeed today we will be looking at so many of our themes being in play that it is hard not raise a wry smile. So let me start with the apparent news that an institution which is one of the world’s biggest control freaks is considering some ch-ch-changes.

The BOJ will also consider loosening its grip on yield curve control (YCC) to allow super-long interest rates to rise more, as its dominance in the market keeps yields in an extremely tight range, they said.  ( Reuters)

I have no idea where the journalist thinks they are going with the reference to “super-long” but anyway here is a reminder of what Bank of Japan yield curve control is.

With this in mind, yield curve control, in which the Bank seeks a decline in real interest rates by controlling short-term and long-term interest rates, has been placed at the core of the new policy framework.

So control-freakery as we note the more precise details below.

The long-term interest rate:
The Bank will purchase a necessary amount of Japanese government bonds (JGBs) without setting an upper limit so that 10-year JGB yields will remain at around zero percent.
While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices.2

They have bought just under 534 trillion Yen of them which I think is a new record in terms of large numbers for us. So we can mull “the yields may move upward and downward to some extent ” because if you wish to buy a Japanese Government Bond you do so at a yield and price which the BOJ has decided. Just in case that point was not rammed home you may note I have left point 2 in above. What does it say?

In case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately.

So yields may move up or down just not up! Indeed as I have been pointing out for a while not down either. This is because the purchases are at or very close to 0% for the ten-year yield which keeps it there when otherwise it would have gone much lower. Otherwise it may well have been more like Germany with its benchmark yield more like -0.5%, so this has been a shambles which most have ignored. It was supposed to cap yields and instead put a floor under them.

What can the Bank of Japan do? Blame the markets as they can’t really complain because they do not exist anymore.

“Prolonged easing has made markets rigid and complacent, so the BOJ needs to change that,” one of the sources said.

“The key is to heighten flexibility in the BOJ’s policy so it can respond to any big shock effectively,” the source said on condition of anonymity, a view echoed by four other sources. ( Reuters)

So the open mouth operation is to blame somebody else which the journalist has fallen for.

The Tokyo Whale

We can now switch to the 35 trillion Yen of purchases of equities which have helped drive the Nikkei 225 index above 28,000. Indeed it was up another 391 points at 26,833 overnight. Whenever there is a down day the Bank of Japan buys providing a put option and acquiring the moniker of The Tokyo Whale.

TOKYO, Jan 18 (Reuters) – The Bank of Japan will discuss ways to scale back a controversial programme that buys massive amounts of exchange traded funds without stoking market fears of a full-fledged retreat from ultra-loose policy, sources say.

Again we are back to the concept of “market fears” when policy has been to destroy the market. So we are in a blame game. In this instance the market has not be a neutered as the bond market bit there is an issue.

The programme will come up in the BOJ’s March policy review, largely because of policymakers’ concerns over the ballooning size of the central bank’s stock exchange-traded funds (ETF) holdings which, at 35 trillion yen ($337 billion), account for roughly 80% of Japan’s ETF market, said five sources familiar with the BOJ’s thinking. ( Reuters )

Have you noticed that however much the BOJ increases its purchases it still apparently only holds 80% of the ETF market? Regular readers will find something familiar about the next bit from Reuters.

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It also pledges to buy ETFs at an annual pace of up to 12 trillion yen, although actual purchases have slowed well below this level in recent months as Tokyo stock prices rally.

Remember 2/3 years ago when we were told by the media that the BOJ was going to taper its ETF purchases? Well that was from 6 trillion whereas now it is 12 trillion. Up was the new down. The next bit is rather revealing as why is it buying at all when markets are calm?

The BOJ will also look at ways to more flexibly slow ETF buying when markets are calm, the sources said.


So is The Tokyo Whale getting cold feet? I do not think so. Central banks indulge in so much PR these days or what we have come to call “Open Mouth Operations”. This often suggests a reduction in policy as an intention but as I have noted with the ETF tapering plan an intention to taper from 6 trillion Yen a year morphed into buying 12 trillion Yen a year. Indeed even the Reuters leak hints at this sort of thing.

While replacing the numerical guidance on the pace of ETF buying is among options being discussed at the BOJ, some are cautious for fear of triggering a market sell-off, they said.

The last thing the BOJ wants is a communication mishap that jolts markets at a time many Japanese firms close their books at the March fiscal year-end.

When you force a market to a particular level as the Bank of Japan has done there is no reason for it to stay there should you depart. We are back to Elvis Presley.

We’re caught in a trap
I can’t walk out
Because I love you too much, baby

If investors wanted to buy the Nikkei 225 at 28,000+ they would have bought it but the BOJ would not wait. Even worse for it many will have bought learning on its purchases and thus may sell if it exits. So it can talk as much as it likes but unless the world suddenly has a lust for Japanese equities how can it even stop buying without the market dropping? Let alone ever sell.

The bond market one is different because the BOJ completely misfired here and in price terms rather than keeping it up it has prevented it from rising as I explained earlier. With the Japanese concept of “face” it cannot admit this but it could buy at different levels which might mean letting the “market” rise and yields fall. Awkward.

With Japan’s large national debt and fiscal deficits it has to keep buying in some form as the government’s position would deteriorate quickly should bond yields rise.

So in summary the BOJ is in a mess of its own central planning making. If we switch to the objective of inflation at 2% per annum all I see is utter failure.

  The consumer price index for Japan in November 2020 was 101.3 (2015=100), down 0.9% over the year before seasonal adjustment, and down 0.4% from the previous month on a seasonally adjusted basis.

All that effort for prices to go nowhere. The truth is that the bond purchases oil the wheels of government spending and the equity ones give profits to those owning equities. So some gain but remember others lose as for example any long-term saving at these levels looks expensive at best.

Also there is no real market or price discovery. In response to this news the Japanese bond future dropped 30 ticks from 151.88 which is not much and then closed at 151.72 as people realised a reality where the BOJ is trapped.

Oh, oh I’m trapped
Like a fool I’m in a cage
I can’t get out
You see I’m trapped
Can’t you see I’m so confused?
I can’t get out ( Colonel Abrams)

There is some inflation around as Platts noted last week but best of luck with telling Japanese consumers it will make them better off.

 In Japan, day-ahead power prices breached Yen 220/kWh, or $618/MMBtu on Jan. 12, Japan Electric Power Exchange data showed. This compares to around Yen 100/kWh a week earlier and single digit price levels in December, indicating a surge of more than 40 times.


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