Japanese Government Bonds: The Bank of Japan is swallowing everything

One of today’s peculiar dynamics has been the fantastic rally (falling yields) of Japanese Government Bonds (JGBS). Yields of JGBs, despite the target doubling of BoJ’s balance sheet in 2 years (2013-2015), have almost returned to pre-Abenomics levels.

Ironically, the private sector led by the banks has pared down substantially their JGB holdings. Between March and August the Bank of Japan (BoJ) reports that the major domestic banks, once aggressive buyers, considerably reduced their JGBs holdings by 24% to ¥ 96 trillion, according to a report from Reuters.

JGBs held by non-residents likewise fell in June to Y81 trillion  from Y82 trillion. Overseas investor holdings of JGBs likewise fell .4% year on year in June, according to the Mni Market news of the Deutsche Borse.

So with the private sector selling, this leaves the Bank of Japan as the major buyer.

JGB holdings by the BoJ has skyrocketed from pre-Abenomics levels at about ¥ 98+ trillion yen to ¥ 126+ trillion yen or a growth of 25.5%. over the past 6 months. Chart from Japan Macro Advisors.

The Zero Hedge points to the ballooning JGB bubble (bold original)

The Bank of Japan's governor Kuroda proudly told the world "long-term yields are bound to rise at some point, but we can curb it when it happens," and on a grand scale - that is what they have done (for now). But market participants are growing increasingly concerned. As we have warned numerous times, the suppression of 'normal' volatility in teh short-term can only lead to larger uncontrollable moves in the future. As The FT reports, some worry, too, that the BoJ has pushed up JGB prices to the point where interest rates no longer bear any relation to the government’s creditworthiness - "effectively we have removed the light from the lighthouse." Some say the transition has been unsettling as many analysts talk more openly of the risks inherent in what the BoJ is trying to pull off. For one thing, liquidity has evaporated... "volatility looks low now, but if some investors start selling, the impact on the market could be much bigger than expected. That is a big risk."

As if to support this view that the Japanese are hiding reality, the US Treasury had some thoughts:

• *U.S. SAYS IT WILL CLOSELY MONITOR JAPAN FOR DOMESTIC DEMAND

Realized vol has collapsed in JGB rates (but forward implied volas for Japan swaptions is surging again)...

The following are noteworthy quotes from the Financial Times article as cited by the Zero Hedge (bold, italics and underline original)

But some say the transition has been unsettling. Analysts are beginning to talk more openly of the risks inherent in what Mr Kuroda is trying to pull off.

For one thing, liquidity has evaporated. Banks that used to be busy making markets for private-sector institutions say they have been marginalised...

“If a client asks us to bid it’s easy, as the market is very, very stable,” says one dealer who asked not to be named. “But if a client comes with an offer, it is a problem, as the duration to cover a short position is much longer and no one is offering. The BoJ is swallowing everything.”

While there has been a massively inflating bond bubble orchestrated by BoJ’s Kuroda which has temporarily succeeded to bring down yields, reducing ‘risk free’ collateral from the banking system has its consequence. When markets encounter turbulence or when banks are required by regulators to meet specified capital ratios, the growing lack of supply of JGBs will eventually incite volatility.

So far, the Japanese yen appears to be holding ground, despite the goal of Abenomics to hit 2% inflation target. Yet if the yen fails to break from the current consolidation phase, this likely means that the BoJ’s objectives will founder. 

Said differently, whatever short term gains acquired from the recent spike in money supply over the past 6 months, may not be enough, such that this will instead result to a reversal of those gains. Boom will turn into a bust.

So I expect the BoJ to ante up on their means to attain their inflation targets in order to kick the proverbial can further down the road or to avoid an interim bust.

Curiously the chart of the Nikkei and the yen appears to reflect on each other, albeit there has been little signs of symmetry in their (yen-nikkei) flows. 

The conditions of the yen and the Nikkei, along with the JGBs will highlight on the whereabouts of the stages of Japan’s inflationism.