Stability in the Japanese government bond market is “extremely desirable,” said Bank of Japan Governor Haruhiko Kuroda in a sign of just how frazzled he was after the turmoil and craziness that his over-the-edge experimental monetary policy has unleashed. “We are going to conduct our market operations in a flexible manner to head off, as much as possible, volatility in long-term interest rates,” he explained.
And he had some explaining to do. I’d always thought that the BOJ could control the Japanese Government Bond market with an iron fist, backed by the omnipotence of the printing press and supported by government-owned institutions that hold a big chunk of those JGBs, such as the Government Pension Investment Fund and the Post Bank. And then there are financial institutions that the government can lean on. So if the BOJ and the government work hand in glove, they can exercise total control over the government bond market. Or so it seemed.
But since April 5, doubts have crept into the scenario. That was the day when 10-year yields dropped to 0.315%, a record low, only to more than triple over the next six weeks to 1.0% on Thursday, the highest in a year. These yields are still very low, but the fact that they jump around like this, that there is such volatility suddenly in the system, that they rise at all when the BOJ is doing its darnedest to repress them, that’s a sign that it might be losing its grip – and that it will take desperate, ever more extreme measures to not lose its grip.
And it did. It was able to force yields back down by throwing a truckload of money at the market. On Thursday, it bought ¥2 trillion ($19 billion) in JGBs and on Friday another ¥900 billion ($8.9 billion). About $28 billion, in just two days. Thankfully, for the BOJ, the Nikkei began to crash, and suddenly these despicable JGBs that everyone had been dumping while holding their nose seemed like a pretty good deal; and demand stabilized.
Along with the chaos in the JGB market, the insanity of the ever skyrocketing Japanese stock market suddenly turned into a rout Thursday morning. After an early 300 point run-up, the Nikkei plunged 1,460 points from its peak, or 9.2%, to 14,484. Friday morning, it jumped over 500 points in a few minutes to 15,008 in a bout of post-crash buy-buy-buy. But then it plummeted over 1,000 points to 13,982, before it jumped over 600 points to 14,612, ending up 128 points, or 0.88%, for the day. What breathless rollercoaster craziness.
This is what happens when the allure of central-bank money-printing erects a wall of illusion between stock market and reality: there is no longer any underpinning. Everything is hype and printed moolah. But when the hot money decides to leave, the air hisses out of that bubble, and markets swoon.
The BOJ has a policy of buying equities to prop up the Nikkei, but Thursday it was furiously propping up JGBs and let the Nikkei go. Friday it might have had a hand in the stock market. When push comes to shove, the BOJ will support JGBs, its number one priority, and let stocks die. But what if it’s losing control of the JGB market, if in the end it’s the only one buying this despicable paper while institutions and individuals are dumping it?
Kuroda refused to comment on the “daily movements” of the markets. But Prime Minister Shinzo Abe was worried: “Sharp increases in long-term interest rates could have a grave impact on the economy and the government’s fiscal conditions,” he told Parliament on Friday. “We expect the BOJ to respond appropriately to any developments in the market.” Appropriately meaning with unlimited magnitude.
Alas, there is no incentive for anyone else to buy this crap, with inflation engineered to exceed yields, and with risks so deep that if you open your eyes and you look down at them, you get woozy. An advisory panel to the Ministry of Finance had warned Abe earlier this week about precisely that problem: there’s “absolutely no guarantee” that Japanese investors will continue to buy JGBs; those who lose confidence can easily invest their funds overseas, the report nervously pointed out.
Investors are already making that shift. The BOJ, which had been planning to mop up around 70% of the flood of new bonds – ¥43 trillion ($425 billion) in fiscal 2013, or 46.4% of the entire budget! – might have to buy all of them. Pure monetization, and there won’t even be the normal fig leaf to paste over the forbidden parts.