Never has a Bank of Japan policy decision garnered this much global attention, nor have punters ever been so confused about what’s to come out of Tokyo.
Fresh from stealing the show in Jackson Hole, Gov. Haruhiko Kuroda has engaged in some curious monetary tweaking moves. Case in point: a steepening of the yield curve as the BOJ buys fewer long-dated government bonds and loads up on more short-term ones. Word is, Kuroda is generating this conundrum to show bankers he feels their pain as negative interest rates slam profits – the debt market corollary of Bill Clinton’s 1992 “it’s the economy, stupid” ethos.
If Tokyo isn’t careful, it may suffer another Clinton administration phenomenon: the bond vigilantes. Back in the early 1990s, Clinton guru James Carville mused that he’d like to be reincarnated and return as the bond market so he can “intimidate everybody.” Then, the White House was feeling the pain as vigilantes, angered by fiscal trends, drove yields higher. The question for Japan is this: Will Kuroda’s tossing banks a bone at the expense of bond traders prompt vigilantes to take things into their own hands?
In one sense, the BOJ enjoys a spectacularly captive audience. For decades now, Japanese government bonds have been the linchpin financial asset held by, well, everyone: banks, pension funds, multinational companies, insurance companies, government institutions, the postal savings system, universities, endowments and retirees. Because it amounts to mutually-assured mass destruction, all efforts go toward taming a $10 trillion-plus JGB monster. The BOJ and Finance Ministry work in unison to keep the world’s biggest bond bubble from bursting.
Japan’s debt to gross domestic product ratio – approaching 250 percent – dwarfs those of Greece and Italy. Combine that with a shrinking and aging population, negligible growth, persistent deflation and 10-year yields at an impossibly low 0.04 percent and you understand why Tokyo’s credit rating is lower than Beijing’s. On the plus side, the BOJ’s massive purchases have sedated the market and killed conventional price action. And more than 90 percent of JBGs are held domestically, making it hard for external forces to commandeer the market.
This arrangement will continue, until it can’t. For many, the moment when an unstoppable force (Tokyo’s borrowing addiction) met an immovable object (bond vigilantes) seemed about to arrive on Sept. 6 when Tokyo sold 30-year JGBs. Thankfully, a crisis was averted as bids outnumbered issues on offer 3.13 times. But that didn’t settle the matter. Was Japan Inc. circling the wagons to ensure calm in bondland? Was it genuine demand? Or was it based on moral hazard – the idea that Kuroda this week will toss more monetary narcotics at an already inebriated market?
We’ll find out Wednesday, when the BOJ’s two-day meeting concludes. Kuroda faces three options, one less palatable than the next. One, increase bond purchases again to halt the yen’s rise and cheer the Nikkei. Two, move further toward negative rates, disappointing markets, while offering bankers a lifeline with an “operational twist” that steepens the yield curve. Three, do nothing, sending jittery markets reeling and more economists writing “Abenomics” obituaries.
Choice No. 3 is the gutsiest, but least likely. One could view the rise in longer-date JGBs as a sign the BOJ is tapering a bit. In the same week bond traders lost sleep over a 30-year action, though, Kuroda met with Prime Minister Shinzo Abe. There, they reaffirmed their willingness to cooperate to boost demand and wages. Translation: Abe is strong-arming Kuroda to open the floodgates even more because, let’s face it, his government isn’t about to do anything on supply side with reforms. If Kuroda disappoints, Abe will be mulling a replacement.
Choice No. 2 has its merits. As Tomoya Masanao, head of portfolio management at PIMCO, puts it, targeting the yield curve, “could mark a new chapter for the BOJ and for global central banking.” And with the Federal Reserve also making a rate decision Wednesday, we’ll see.
I worry, though, that it’s a policy Band Aid that placates Nomura and Mitsubishi-UFJ with little hope of jump-starting growth. The same goes for option No. 1, the most likely call. But even more stimulus gets Japan no closer to increased competitiveness, innovation and living stands.
Kuroda has his three choices, but the answer is obviously Abe’s three arrows – monetary, fiscal and deregulatory action. Since December 2012, Abe has talked big about removing the many blockages clogging Japan’s arteries. Instead, he’s treating the patient with sedatives and avoiding the underlying malady.
That’s fine for today, so long as the bond vigilantes stay calm. Kuroda can hold them, and a dangerous yield spike, off for a while. But there’s a limit to any market’s tolerance. If traders decide there’s nothing else to Abenomics, just more debt and BOJ stimulants, they may shift into intimidation mode.