Boomeranging BoJ’s NIRP: JGB Circuit Breaker, Corporate Bonds and Bank Lending Slows as Cash Hoarding Accelerates!

In this terse post, I’d like to only discuss two things: one, the immediate unintended side effects of the Bank of Japan's (BoJ) NIRP, and second, the growing political divide over the imposition of NIRP.

Yields of Japan’s Government Bonds (JGB) shockingly collapsed yesterday to have forced the government to implement a circuit breaker or the suspension of trading activities for JGBs.

From Bloomberg:

Trading of Japan’s government bond futures for delivery this month was halted for less than a minute after the price of the contracts dropped as much as 0.6 percent.

The so-called dynamic circuit breaker started at 12:32 p.m. in Tokyo and only applied to March contracts for about 30 seconds Wednesday, according to Masaki Takahashi, who works in the market management department at the Osaka Securities Exchange.

The underlying benchmark 10-year bond tumbled Wednesday, pushing yields up eight basis points to minus 0.015 percent as of 2:51 p.m., according to Japan Bond Trading Co., the nation’s largest inter-dealer debt broker. Yields rebounded after dropping more than five basis points to a record minus 0.1 percent Tuesday.

Wednesday’s slide was partly driven by the results of the Bank of Japan’s bond buying operation, according to Takenobu Nakashima, a quantitative strategist at Nomura Securities Co. in Tokyo. Its bid-to-cover ratio for debt with 10 to 20 years to maturity rose to 3.58 from 2.93 last week, indicating stronger investor demand to sell.

It is important to highlight that with the BOJ holding 34% of the JGB market as of January 2016, shrinking market liquidity PLUS NIRP has been contributing to the current increase in JGB market volatility

Yields of Japan's 30 year bonds also crashed

Of course, the aim of the BoJ's previous Zero Interest Rate Policy (ZIRP) has been to bolster credit growth.

For the private sector this hasn’t been happening. To the contrary, credit growth has been materially slowing, notes the Japan Macro Advisors: (bold added)

In February 2016, the growth in the total bank lending in Japan slowed slightly to 2.2% year on year, down from 2.4% in January. The bank lending growth seemed to be on a deceleration path, having peaked in August 2015 at 2.7%.  

The sign of a slowdown is even sharper in bank deposits. It has decelerated from the peak of 4.6% in May 2015 to 3.1% in February 2016. The slowdown in deposits growth could be a reflection of a slowdown in the economy. In the quarterly published statistics, we see that the housing loan lending has been slowing since last summer. In the October-December quarter, new housing loans has grown negatively by -6.4% year on year.

With ZIRP being unable to fulfill what it had been designed for, the BoJ has doubled down to merge ZIRP with NIRP.

Unfortunately, stagnation in bank credit growth seems to be the initial outcome, since the NIRP took effect on mid February.

The corporate sector seem to be reluctant to issue bonds. Worst, credit risk has been rising on corporate bonds.

From Nikkei Asia (bold mine)

The Bank of Japan's negative rate policy is beginning to distort the way corporate bond rates are set.

Default risk premiums are rising even though the creditworthiness of issuing companies remain unchanged. This is because many companies prioritize keeping interest rates positive to rope in buyers.

With some companies becoming less willing to issue bonds, some market insiders are wondering if the corporate bond market will shrink…

However, the BOJ's negative rate policy has caused JGB yields to significantly decline, affecting corporate bond rates, too. In some cases, total interest rates are negative even if default risk premiums are added, making it difficult to attract buyers.

And more signs of distortions on Japan’s corporate bond market.

Interest rates on logistics company Nippon Express's five-year bonds and on seasoning maker Ajinomoto's seven-year bonds were decided based on an absolute level of interest rates. This method has become the norm when issuing bonds with maturities of less than 10 years now that yields on 10-year JGBs are negative.

That said, there is a problem in adopting an absolute level of interest rates. The corporate bond market's system of assessing a company's creditworthiness based on risk premiums could become dysfunctional…

In the secondary market, a strange phenomenon is taking place: The risk premium tends to be larger for corporate bonds with higher creditworthiness. That's because, with JGB yields tumbling, creditworthy companies are forced to set much higher premiums to keep their already-low bond rates positive.

As a result, the spread between premiums on higher-rated issues and lower-rated issues has narrowed, causing "creditworthiness-based yardsticks" to collapse and making it difficult for some investors to manage their portfolios.

More signs of NIRP backfire…credit growth diminishing not only in Japan but also in Europe:

Rising default risk premiums are making some companies less willing to issue bonds. One financial officer of a company listed on the first section of the Tokyo Stock Exchange is worried that an increase in premiums could deteriorate his company's loan terms. Default risk premiums on corporate bonds are an important factor when coming up with borrowing rates. Therefore, higher risk premiums could work to the disadvantage of companies when taking out loans in the future.

Bond issuances are on the decline in Europe, which adopted a negative rate policy ahead of Japan. The amount of corporate bonds issued in 2015 tumbled 20% from 2013, before the negative rate policy was adopted, according to U.S. market research company Dealogic.

With NIRP providing less income for financial services firms, as well as, security for depositors, the initial ramification has been for the both parties to withdraw from the system.

Money market funds, mutual funds and insurance pullback from providing services to consumers.

First money market funds, from another Nikkei Asia report: (bold added)

With negative interest rates making stable returns impossible to achieve, all 11 Japanese asset managers running money market funds plan to close them and return assets to investors, effectively ending a once-flourishing market.

Money market funds invest mainly in short-term instruments such as commercial paper and government debt carrying maturities of less than a year. Though principal is not guaranteed, these investment trusts have been considered safe. Japanese money market funds held 1.37 trillion yen ($12 billion) in assets Friday…

Money market funds were introduced in Japan in May 1992. Retail investors were drawn to their safety and higher returns compared with bank deposits. Total assets in money market funds peaked at 21 trillion yen in May 2000. But their popularity waned after the 2001 collapse of U.S. energy company Enron, which caused the money market funds holding its debt to drop below par value.

Next, mutual funds and insurance.

The impact of negative interest rates is spreading to other financial products. Returns have sunk below 0.02% for money reserve funds, mutual funds similar to money market funds with assets totaling more than 10 trillion yen. Because these funds serve as settlement accounts used in stock and mutual fund trading, returning customers' assets is difficult. Asset management companies can cover losses to keep their value above par but bear the cost of doing so.

Some life insurers are halting sales of products aimed at savers. T&D Financial Life Insurance will suspend sales of some single-premium whole-life policies March 16.

NIRP appears to be on path to destroy Japan’s financial system. 

Instead of ‘financial inclusion’, Japan financial system could be headed for atavism where unbanked people will swell. And by widening the chasm between savings and investments, the retrogression in Japan’s banking and capital markets will lead to lower standards of living which will likely be highlighted by a massive crisis (which will likely spread elsewhere)

And as the BoJ increases their share of JGBs, it means lesser private sector participation on the JGB market. 

From another Nikkei Asia article:

Because Japanese interest rates keep falling amid the BOJ's incremental monetary easing, foreign pension funds, as well as Japanese banks and pension funds, have been reducing their JGB holdings. This has increased the relative proportion of speculators in the market, making bond yields more susceptible to volatility.

This only means that the price function of JGBs has been rendered materially broken, thus the enhanced volatility. Yet the BoJ hopes to ingest a larger segment JGBs in order inflate away such unsustainable debt levels via the NIRP.

And as noted above, depositors have been withdrawing from the system

From another Nikkei Asia article

Japan's cash in circulation is growing at the fastest rate in 13 years as ripples from the Bank of Japan's negative interest rates push consumers' money out of savings accounts and into safes and other at-home repositories.

Japan had 6.7% more currency in circulation in February than a year earlier, the BOJ reported. That increase is the largest since February 2003, when consumers withdrew cash following changes to Japan's deposit insurance system. Particularly popular now are 10,000-yen ($88.25) bills, with circulating stock surging nearly 7%, the central bank said. The 5,000-yen and 1,000-yen bills have seen upticks of less than 2%.

The consumer shift from banks to home safes

Consumers increasingly find that keeping money in the bank is simply not worth the trouble. Large banks are paying a mere 0.001% interest on deposits -- 10 yen per year for an account holding 1 million yen. ATM fees and other charges would put many savers at a loss.

Instead, many are looking to safes to protect their money at home.

"Safes have really taken off since the negative-rate policy was announced," a worker at a major Tokyo home electronics retailer said. Fireproof models selling for around 50,000 yen are especially popular. Shimachu, a home goods chain based in Saitama Prefecture, reported twice as many safe sales now as a year ago. Commercial security provider Kumahira noted growing interest in safes from businesses as well.

Keeping cash in the home entails a higher risk of burglary. Sohgo Security Services said that requests for information on home security systems have risen 10-20% since the BOJ's negative interest rates took effect in mid-February, though the company admitted the cause of the increase is unclear.

The articles conclusion:

The central bank's negative rates are intended to push funds into consumption and investment -- not safes and mattresses, where they do nothing to stimulate the economy. Switzerland, a pioneer of negative-rate policy, apparently experienced similar unintended consequences: printing of 1,000-franc ($1,003) bills, the largest available, surged when rates dipped below zero.

Notice that much of the adverse reports came from Nikkei Asia, a mainstream media outfit that used to be the administration’s megaphone? Now the same firm appears to be pushing back hard on the BOJ’s NIRP as I have earlier noted here.

It’s a sign of a growing divide on NIRP by Japan’s establishment. It won’t be long where the BOJ may not just be kiboshed by the marketplace but by politicians as well. Such are growing signs of inherent barriers to the BoJ’s rampant inflationism. 

 

So far Japan’s stocks have partly recovered since the BoJ’s NIRP’s announcement.

The Nikkei was up 1.26% today, as part of the ongoing counter trend (bear market) rally.

The Nikkei has, so far, been short of reaching January highs when NIRP was announced. But volatility should be expected given the severe real world dislocations brought about by NIRP.

Nevertheless, people pulling their money out of the financial system will serve as a nasty headwind for Japan’s assets. That’s unless the average citizens will see stocks as a refuge. But if they do so, then NIRP will just blow another huge bubble from which will eventually implode and send even more people to scamper outside the financial system.

Yet the BoJ has positioned itself where there seems NO way out.

It’s sad to see how desperate central bank policies will lead to MORE societal hardships.