Bank of Japan Buys JGBs at Unprecedented Negative Rates!

Evolving developments on the financial markets have really been in uncharted waters. The Bank of Japan (BoJ) has reportedly been monetizing JGBs at negative rates, part of which has been an outcome from the ECB’s recent policies

From the Wall Street Journal Real Times Economics: (bold mine)

Tuesday marked another milestone in the topsy-turvy world of monetary easing in Japan: The Bank of Japan bought short-term Japanese government debt at a negative yield for the first time, according to market participants.

The BOJ scooped up some of the three-month No. 477 Treasury bill, which has traded at a negative yield for the past two trading days amid strong demand, the market participants said.

Normally, people who buy debt expect to get their money back plus some interest. Negative yield means the buyer gets back less than he or she puts in.

The reason for this

Traders said the bank wanted to show the market that it would meet its asset purchase goals–literally at whatever the cost.

The BOJ buys Treasury discount bills as part of its asset purchase program aimed at reaching 2% inflation. The bank has a ¥270 trillion monetary base target it wants to reach by the end of the year. By purchasing the Treasury bills, it increases the amount of cash in the financial system, getting closer to the target. 

Market participants say the bank probably didn’t foresee buying Japanese debt at negative yields. But the European Central Bank’s easing has created demand for short-term Japanese debt from European investors, to the extent that interest rates have turned negative.

Essentially this means the Bank of Japan (BoJ) financing (monetizing) the Japan’s government debt (JGB) at negative rates.

The Japanese government should be delighted that they have been able to push rates even to negative. But of course there will be unintended consequences. 

Note that even policymakers have not anticipated such an outcome. Besides, interventions by other central banks on their domestic markets such as by the ECB’s recent QE have been amplifying imbalances in the global bond markets.

The Bank of Japan now holds about one-fifth of outstanding JGBs. By the yearend these are expected to reach a quarter (Japan MacroAdvisors). Foreigners own just 8.4% of both JGBs and Japanese T-Bills as of March 2014 according to the Ministry of Finance.

If Euro participants and or the others continue to bid on JGBs, negative T-Bills could drive buyers to the longer end, thereby pushing Japan’s yield curve to flatten or even go negative. An inverted yield curve may reinforce the prospects of a recession. Japan’s 2Q GDP has been revised from –6.8% to a larger 7.1%! One more quarter of negative GDP and Japan will be technically reckoned as having entered a recession.

So far, central bank interventions has caused massive pricing distortions in the Japan’s bond markets (as well as global bond markets). This implies skewed interest rates which subsequently contorts discount rates, profits and returns. All these translates to even more misallocations of resources in the real economy and the financial markets.

The other source of risk could be in liquidity of JGBs. Last April, JGBs had reportedly no transactions within a day. A prospective disruption in the financial markets may be amplified by a liquidity shortage in the bond markets.

For now these zero bound/negative rates seem viable only because of the risk ON environment. 

The BoJ has been trying to reach its 2% inflation target by hitting the ¥270 trillion monetary base target as noted in the above report. But the growth trend in Japan’s money supply (M2) appears to have already reversed. This reversing trend seem as apparent even in the Wholesale Price/ Producer’s Price Index in August which reported a 3.9% increase. (both charts from forexfactory.com). 

Official inflation rate based on July seem to also have inflected. In short, the BoJ's target could be in jeopardy.

The 2Q GDP slump could be a repercussion from falling growth of money supply, compounded by the uncertainties from tax and other market interventions.

The seeming deterioration in Japan’s economy continues as consumer and business spending remains sluggish, according to the Zero Hedge. 

Today’s machinery report while posting a +3.5% was significantly below consensus expectations of 4.1%

Why has this been happening? Simple, because the Japanese political economy is being choked from a torrent of political interventions. 

As I previously wrote:

It’s a wonder how the Japanese economy can function normally when the government destabilizes money and consequently the pricing system, and equally undermines the economic calculation or the business climate with massive interventions such as 60% increase in sales tax from 5-8% (yes the government plans to double this by the end of the year to 10%[21]), and never ending fiscal stimulus which again will extrapolate to higher taxes.

The mainstream has all been desperately scrambling to look for “green shoots” via statistics. They fail to realize that by obstructing the business and household outlook via manifold and widespread price manipulations, this will only lead to not to real growth but to greater uncertainty which translates to high volatility and bigger risks for a Black Swan event.

Don’t worry be happy, Japanese stocks, in anticipation for more rescues from PM Abe and BOJ's Kuroda, continues to surge.