JGB Watch: Cracks in the JGB Bubble? Yields Spike Across the Curve!

Very interesting turn of events in Japan’s sovereign debt markets last week…

From Nikkei Asia: (bold mine)

The yield on newly issued 10-year JGBs touched a two-month high Friday, driving the yen higher against the dollar on the one hand and putting a damper on stocks on the other.

The benchmark yield has been climbing since Jan. 20, when it hit a record low of 0.195%. Growing market skepticism over the Bank of Japan's quantitative easing policy is cited as a major reason.

A Ministry of Finance auction of five-year JGBs proved lackluster Friday, with the bid amount dropping to the lowest level since April 2013. JGB sell-offs ensued after the auction, and the long rate surged 3.5 basis points at one point to 0.435%.

Bond uncertainty is rippling through other financial markets. The Japanese currency swung around 0.5 yen higher against the greenback at one point in Friday trading, while the Nikkei Stock Average's slide picked up speed.

An interest rate spike calls for skepticism over the effectiveness of the BOJ's monetary policy," said Minoru Uchida of Bank of Tokyo-Mitsubishi UFJ. "With no additional easing on the radar, the weak-yen scenario backed by easy money is losing ground."

First of all, we can do away with the negative spin that recent actions by the JGB has been a “damper on stocks”.

For the week, the Nikkei has been up 1.5% and the Topix 2.27%. Year to date, as of Friday’s close, both equity bellwethers have been up 2.65% and 2.97% respectively

Also we can do away the claim that “Bond uncertainty is rippling through other financial markets”. That’s because Europe and US stock markets are at record levels while as much 16% of global bond markets have been negative yielding according to the Wall Street Journal Money Beat Blog. 

As for negative bond yields, we have come point where savers and lenders even pay borrowers to lend money!

With credit risk priced out of existence, it’s a sign of a massive breakdown of incentives undergirding the current global financial markets. It’s now about borrow, borrow, borrow and spend spend spend!

With savings and production sidelined, all the rest of growth statistics have transformed into smoke and mirrors!

But there is another potential reaction from negative yields, which has not been in the radar screens of policymakers…cash hoarding! Some dynamic we are likely to see in the future.

Back to the uncertainty effect of JGBs. The yen was up this week against the US dollar by about .3% this week. Where destruction of the currency has been seen as a benefit, then a rising yen may have been perceived as part of “uncertainty”

10 year JGB yields have been on the upside since a month ago as shown in the chart from Investing.com. So this has little to do about a rippling effect…so far.

And rising yield has been across the yield curve 1, 2 and 3 year (they had been at the negative zone last month but has now moved into the positive), the  5 year 7 year, 9 year, 15 year, 20 year, 30 year and 40 year have all resembled the 10 year (as seen from a 1 year perspective). So milestone high stocks comes in the face of a bond market selloff!

But aren’t JGBs supposedly an example of “we owe it to ourselves”? 

The unstated purpose of Abenomics  has been to vanquish interest rates, which should lower debt servicing cost thereby buying time for the Japanese government to manage her increasingly untenable debt levels. Another undeclared purpose has been to inflate away her debts.

Unfortunately, what seems may not turn out as reality.

The lackluster demand for the 5 year JGBs auction which added to the surge in yields last week, and where rising yields again has been a one month dynamic, exposes on the myth that government debt is a free lunch. JGBs are sensitive to the markets after all!

The share of JGBs held by the Bank of Japan via Abenomics has now risen to 25%.

According to Japan Macro Advisors: In terms of the BoJ's market share in the JGB market, it renewed its new peak. In January 2015, the BoJ owned 25.6% of the JGB market, measured in value, and 20.9% measured in aggregate duration risk. We expect BoJ's market share will exceed 30% by the end of 2015, and approach 40% by the end of 2016.

So by siphoning liquidity out of the JGB markets, the ramifications of BoJ’s actions has been to increase volatility. Such volatility has emerged in the form of reduced demand for JGBs that has spiked yields. Current events may signify as the unintended long term consequences from the BoJs inflationary policies.

As far back during November 2013, I quoted a market participant who called the end of the JGB market: “The JGB market is dead with only the BOJ driving bond prices...These low yields are responsible for the lack of fiscal reform in the face of Japan’s worsening finances. Policy makers think they can keep borrowing without problems.”

I have also warned in the past that not only has the BoJ sucked liquidity out of the system, and not only has QE broken the price discovery mechanism of the JGBs by skewering the incentives of the marketplace, importantly there will be other implicit effects via the banking and financial system: “Such massive misalignment in the JGB markets entails magnified unseen risks in Japan’s banking and financial system who owns a bigger share of JGBs. And the possible channels for these could cover collateral, capital adequacy and more…

Thus JGBs have been a ticking time bomb (which I previously called this a potential Black Swan).

Finally the article above has a a striking quote from a market participant: “An interest rate spike calls for skepticism over the effectiveness of the BOJ's monetary policy”

Has the BOJ been losing credibility? Have markets been embolden to fight or defy them? Has rising yields represented a “short” on the BoJ? Are these signs of a possible inflection point? If so, will this spillover to the other major financial markets?

Hmmmm. We will see.