The Bank of Japan’s governor Kuroda proudly told the world “long-term yields are bound to rise at some point, but we can curb it when it happens,” and on a grand scale – that is what they have done (for now). But market participants are growing increasingly concerned. As we have warned numerous times, the suppression of ‘normal’ volatility in teh short-term can only lead to larger uncontrollable moves in the future. As The FT reports, some worry, too, that the BoJ has pushed up JGB prices to the point where interest rates no longer bear any relation to the government’s creditworthiness – “effectively we have removed the light from the lighthouse.” Some say the transition has been unsettling as many analysts talk more openly of the risks inherent in what the BoJ is trying to pull off. For one thing, liquidity has evaporated… “volatility looks low now, but if some investors start selling, the impact on the market could be much bigger than expected. That is a big risk.”
As if to support this view that the Japanese are hiding reality, the US Treasury had some thoughts:
- *U.S. SAYS IT WILL CLOSELY MONITOR JAPAN FOR DOMESTIC DEMAND
Realized vol has collapsed in JGB rates (but forward implied volas for Japan swaptions is surging again)…
There are few bigger bond bulls than Haruhiko Kuroda.
The governor of the Bank of Japan told a New York forum this month that flat or falling yields in Japan’s Y936tn ($10tn) government bond market “can, and should continue” – even as inflation keeps edging towards the central bank’s target of 2 per cent.
since the end of June, yields have settled into a gentle downward groove, meaning that JGBs have beaten all other markets bar some peripheral Europeans. Bond yields move inversely to prices.
Indeed, on Wednesday the benchmark 10-year yield dropped below 0.6 per cent, to its lowest since early May, stretching away from Switzerland as the lowest in the world, as investors anticipated another firm commitment to easing at the BoJ’s policy meeting on Thursday.
This is what the governor ordered.
But some say the transition has been unsettling. Analysts are beginning to talk more openly of the risks inherent in what Mr Kuroda is trying to pull off.
For one thing, liquidity has evaporated. Banks that used to be busy making markets for private-sector institutions say they have been marginalised
“If a client asks us to bid it’s easy, as the market is very, very stable,” says one dealer who asked not to be named. “But if a client comes with an offer, it is a problem, as the duration to cover a short position is much longer and no one is offering. The BoJ is swallowing everything.”
In the first week of October, for example, the yield on the benchmark 10-year bond moved by just 0.001 per cent, or one-tenth of one basis point, on three consecutive days.
“Volatility looks low now, but if some investors start selling, the impact on the market could be much bigger than expected. That is a big risk.”
Some worry, too, that the BoJ has pushed up JGB prices to the point where interest rates no longer bear any relation to the government’s creditworthiness.
Under its previous governor, Masaaki Shirakawa, the BoJ was always sensitive to the charge that it was indulging a profligate government. Under Mr Kuroda, the bank still argues that because the purchases are not made directly from the finance ministry, they do not fall foul of a 1947 law that banned central bank underwriting.
But it is an increasingly fine distinction, say analysts.
“Effectively we have removed the light from the lighthouse.”
But the bond market seems to be storing up tensions anyway, says Yasunari Ueno, chief market economist at Mizuho Securities.
Investors “should remember”, he says, “that the currently irrational movement will probably translate into a growing momentum for a large price move in the future”.
Or as Taleb wrote: “There is no freedom without noise – and no stability without volatility.”
And always a great read on the real dangers of suppressing natural volatility: