How Abenomics distorts the JGB markets

More signs of contortions in the Japan Government Bond (JGB) markets emanating from Bank of Japan’s (BoJ) implementation of 'Abenomics' as reported by the Wall Street Journal Real Time Economics blog

First, the draining of liquidity

On Monday, the newest 10-year Japanese government bond — the yield on which is used as a benchmark for bank loans and a barometer of trust in government finances — didn’t trade even once.

Traders say it is another sign of how the Bank of Japan’s massive bond buying program has silenced the market.

If the 10-year JGB goes a full 24 hours without being traded, it will be the first time since Dec. 26, 2000, according to the Japan Bond Trading Co., which publishes rates. That seems likely, since most investors close their books at 3 p.m. Tokyo time.

Second the skewering of the market's incentives:

Investors say it is more costly to trade than to sit on the sidelines with rates so low and supply scarce due to the BOJ purchases.

The central bank has also been buying a disproportionate amount of the most recent issues as dealers sell JGBs they buy at auction almost immediately to the BOJ to earn something, in what traders call “the BOJ trade.”

At the end of March, the BOJ owned about 33% of the current No. 333 10-year bond, the one that didn’t trade Monday.

Japan Macro Advisor’s estimate that as of April 7, 2014, the share of JGBs held by the BoJ has now climbed to 22%

Finally how Abenomics has mangled “price discovery”.

It’s not the first time that a scarcity of JGBs caused by the BOJ has created some unusual market milestones. At the end of March, rates in one funding market briefly fell below zero for the first time, as market participants basically offered short-term cash loans at negative interest just to borrow JGBs.

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…

In addition, the flagrant mispricing of JGBs also reflects on bank loan rates and other financial instruments. This extrapolates to a collosal distortion of resource allocation in the financial system and in the real economy, which has also been ventilated via the currency the yen

And such is what makes Japan a ticking time bomb, one of the potential sources of the global financial Black Swan.