By Garfield Reynolds, Bloomberg Markets Live Commentator and Reporter
The pace of this week's Treasuries rout – and post-FOMC relief – has focused most eyes squarely on US markets, but the real action going forward is just as likely to be in Tokyo. The Bank of Japan’s massive debt purchases to cap yields may have already passed their use-by date, and that threatens to unleash fresh storms on global bond markets that are about as stressed as they have ever been.
As everyone is focused on crypto, the real war is taking place in Japan pic.twitter.com/1IIvmCjI9M
— zerohedge (@zerohedge) June 15, 2022
While the Fed’s 75-basis-point hike came with mild-enough forward guidance to soothe panicked markets, the BOJ still faces pressure from a widening policy gap to at least acknowledge it’s time to tweak its own settings when it concludes its own meeting on Friday.
BOJ Governor Haruhiko Kuroda is nothing if not determined, and he has been sticking to his line that the recent pickup in Japanese inflation will be transitory — a word that has fallen out of favor with his peers — meaning that he considers it premature to adjust the world’s loosest policy.
The central bank is doubling and tripling down on buying up ever-greater chunks of what is left of the Japanese bond market to cap 10-year yields at 0.25% and maintain curve control. This week has seen cries that this can’t go on for much longer reach a crescendo.
The yen tumbled through 135 per dollar this week to a 24-year low, which adds to the stickiness for inflation as well as taking the currency down so far that the real-world impacts counteract much of the benefits of easier policy, including by crippling consumer confidence.
The currency’s plunge also spreads turmoil because it means Japan’s deep- pocketed investors — long a key player in Treasuries and other major developed bond markets — need to hedge investments abroad at a time when BOJ-Fed policy divergence is so stark that 10- year US yields are actually negative for yen-based investors.
Expect to see the unexpected “buyers’ strike” from Japanese investors — the largest foreign holders of Treasuries — to go on, exacerbating the unprecedented rout in US sovereign securities and other notes.
As for Japan’s bond market, foreigners are fleeing, except for a few managers willing to take on the BOJ in a classic widow-maker trade and short JGBs. Liquidity deteriorated to the worst since Kuroda took office in March 2013, and JGB futures recently tanked by the most since that year.
There may be no good choices left for Japan’s central bank. If it sticks to its guns it risks further yen declines, adding to rampant dollar strength that is a key pain point for numerous currencies, markets and economies worldwide. The BOJ would also likely end up holding more than half of all JGBs to make dysfunction the norm in one of the developed world’s second- largest bond markets.
But a shift away from curve control would bring its own dangers by turning JGBs from an island of stable returns into yet another bond meltdown. That would be especially cruel for private holders of the debt after curve control saw JGBs miss out on the massive gains Treasuries experienced amid pandemic stimulus.
Japan’s insurers hold about 20% of the country’s 1.2 quadrillion yen ($9 trillion) government bond market, so the potential for severe value-at-risk shocks is massive — this in a market that still shudders at the memories of the 2003 VaR meltdown.
The last thing bruised global markets need is for some of the managers holding Japan’s $1.2 trillion of Treasuries to need to liquidate some of their assets to cover losses.