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