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BoJ QE Exit "Out Of The Question," Former Official Says As Morgan Stanley Talks JGB Liquidity

Tyler Durden's picture




 

We’ve long said that a dramatic and sustained spike in JGB yields would be catastrophic for Japan, whose central bank is onboarding the entirety of gross issuance onto its balance sheet and whose government is running what is effectively the largest ponzi scheme the world has ever known. Here’s WSJ summing up the situation: 

Japan’s government debt is roughly 240% of gross domestic product, according to the latest International Monetary Fund figures. That is the highest in the developed world, and many analysts contend that rising interest rates could stress the government’s finances with higher borrowing costs and hamper the banking system by causing Japanese lenders to see large capital losses on the pile of government bonds they hold.

Given this scenario, the logical conclusion is that there is no viable exit strategy for the BoJ, a sentiment that was echoed this week by Japan’s former chief of foreign exchange policy at the Ministry of Finance who told Bloomberg that unwinding QE simply isn’t an option:

Makoto Utsumi, who oversaw foreign-exchange policy at the Ministry of Finance from 1989-1991, said the Bank of Japan’s expansion of its balance sheet into debt with an average remaining maturity of up to 10 years makes it impossible for Kuroda to pare stimulus “for the foreseeable future” without causing bond yields to surge. Speculation that the BOJ will accelerate its note purchases helped push two-year yields below zero percent on Wednesday for the first time since January.

 

“The thought of exit itself is a nightmare for Japan, not whether it’s premature to talk about it,” Utsumi, 80, said in an interview in Tokyo on April 15. “There is no choice but to keep issuing bonds for financing, and with buying of longer dated JGBs, a natural exit is out of question as is unwinding.”

Meanwhile, the very same asset purchases that have driven down yields have ironically created the conditions for a sudden spike. As we’ve discussed on numerous occasions, BoJ purchases have sucked nearly all liquidity from the JGB market causing traders to report widening bid-asks and increased volatility. If market depth collapses then the impact on price of any one trade is magnified, increasing the chances that a few sellers could create carnage in the market and effectively collapse the entire house of cards in relatively short order. As such, it isn’t entirely clear how an “exit” will ever really work. Indeed, even the most optimistic (in terms of betting on Abenomics to free Japan from deflation) analysts acknowledge that JGB liquidity is impaired to the point of absurdity and will be the “major theme” going forward. Here’s some color from a recent Morgan Stanley note:

Our economics team expects the BoJ to start winding back QQE from October 2016, and cannot rule out a commencement of tapering as early as the first quarter of next year under an economic bull-case scenario of oil prices rebounding strongly and wages providing a solid boost for consumption. Markets are likely to start focusing greater attention on improving macroeconomic conditions and the prospect of BoJ tapering as the inflation rate climbs from this summer onwards, but our base-case scenario is for JGB yields to climb only gradually through the end of 2015, with BoJ operations to continue providing substantial support until tapering actually gets under way.

The underlying inflation rate looks likely to hover around zero through this summer, thereby fueling hopes for further BoJ easing. However, the inflation rate should start climbing year- on-year once the impact of previous falls in oil prices begins to drop out. Our economics team expects the core CPI inflation rate to reach +0.7% by year-end and then approach +1.2% level in 1Q 2016, reflecting both base-year effects and solid growth in household spending if wages do indeed keep rising. Macroeconomic conditions have actually been improving since last summer, with real exports and production rising since September while Cabinet Office Economy Watchers Survey results and other measures of sentiment have picked up sharply over the past few months. 

It goes without saying that we are skeptical of the degree to which Abenomics will be successful at either altering inflation expectations or creating anything that even approximates prosperity for Japan’s Middle Class (in fact, we recently outlined how Abe’s policies are destroying Middle Class Japanese citizens), what we can agree with MS on however, is the following assessment of JGB liquidity:

Market liquidity—or lack thereof as trading continues to thin out—is also likely to be a major theme.

BoJ operations have surpassed even the Fed's QE when measured relative to either GDP or total issuance, with secondary market availability—the total amount of JGBs held outside the BoJ's hands—dwindling since the April 2013 introduction of QQE and shrinking at an even faster pace under QQE2 (launched last October). The resultant decline in market liquidity means that price action is now being driven mostly by the supply/demand pressures associated with MoF auctions and BoJ purchases.

As discussed in our report Japan Interest Rate Strategist: Outlook for JGB Supply and Absorption (05 Mar 2015), if the BoJ persists with its current pace of JGB purchases, then the incentive for investors to reduce their holdings any further is likely to dwindle away within the next 18–24 months, at which point liquidity may evaporate altogether as a consequence of unprecedentedly tight supply/demand.

This loss of market functionality is liable to come just as a rising inflation rate starts to make BoJ tapering look like a real possibility. Upside to JGB yields should be limited to at least some degree by demand from banks (who are currently earning just 0.9% or thereabouts on their loans) and life insurers (who have been comparatively modest net buyers over the past couple of years), but it is nevertheless likely that JGB market participants will start to demand a risk premium when confronted with rising interest rates, high volatility, and the prospect of the BoJ winding back its monetary stimulus in foreseeable future. 

*  *  *

Perhaps Yoshiyuki Suzuki, the head of fixed income at Fukoku Mutual Life Insurance Co. said it best when he told Bloomberg the following: 

“If somebody sells, yields can jump.”

 

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Wed, 04/22/2015 - 20:09 | 6020318 Yen Cross
Yen Cross's picture

 Wi Tu Lo. In,fat,un tawget~no so good.

Wed, 04/22/2015 - 21:28 | 6020531 palmereldritch
palmereldritch's picture

Abenomics: aka 'The Hans Gruber Defense'

http://www.killerclips.com/clip.php?id=70&qid=619

Wed, 04/22/2015 - 21:47 | 6020576 Monetas
Monetas's picture

The Adolf Schicklegruber defense !

Wed, 04/22/2015 - 22:45 | 6020747 remain calm
remain calm's picture

 head of fixed income at Fukoku Mutual Life Insurance Co

Now lets break down the life insurance compay and put it in proper context. FUKOKU = FUK OK U = OK FUK U Life Insurance. So there you have it.

Wed, 04/22/2015 - 22:17 | 6020668 angel_of_joy
angel_of_joy's picture

It's just a different form of seppuku ! Old habits die hard...

Wed, 04/22/2015 - 20:23 | 6020361 will ling
will ling's picture

the insanity doesn't even get much play here on ZH anymore.

Wed, 04/22/2015 - 20:41 | 6020401 NoDebt
NoDebt's picture

When history is written on this period of time it will be marveled at.  "How could they have let it get to that point?"  "Wasn't it obvious they were in a self-destructive loop?"  "Were they crazy?"  "Why didn't they change course when they realized the obvious problem?"

We- you and I and all our leaders, all our institutions- will be written off.  Just another brief time when the world went mad.  None but a few historians will even want to gaze upon this period of time.  We will be hated, derided, criticized, mocked and ultimately, forgotten.

Memoribilia from this time period will go for megabucks on eBay, however.

Wed, 04/22/2015 - 20:32 | 6020382 NoDebt
NoDebt's picture

If you think the Fed has painted itself into a corner, it's nothing compared with the BOJ.

Look, let's be honest here.  All Keynesian levers have been pushed up into the "run until failure" position everywhere in the developed (debtful) world.  Japan is the most screwed of the bunch.  They will go first.  When they fall, others will follow.  All these indebted countries are tied to eachother like a bunch of out-of-shape 300lb. mountain climbers.  When one falls off, their weight will eventually pull the others down with them.  But until that time comes... we're going to have articles like this because NOTHING is going to change until then.  

Wed, 04/22/2015 - 20:36 | 6020393 MATA HAIRY
MATA HAIRY's picture

sell sell sell....turn those machines back on!

Wed, 04/22/2015 - 20:41 | 6020408 Soul Glow
Soul Glow's picture

I haven't bought silver bullion in a few months.  I think I'll buy some on Friday when I go to town.

Wed, 04/22/2015 - 20:56 | 6020445 max2205
max2205's picture

......don't take your love to town.....

Wed, 04/22/2015 - 21:04 | 6020467 BandGap
BandGap's picture

When the music stops the fun starts. Find time to stock up, and save!

Alternate between bullets  and PMs. Another nice investment has been the handguns I bought a few years back. For the very high volume of sales in the past few years they are more than holding their value.

Wed, 04/22/2015 - 21:13 | 6020492 Soul Glow
Soul Glow's picture

Savings should be put into gold and silver en masse.

Wed, 04/22/2015 - 20:58 | 6020450 ebworthen
ebworthen's picture

Of course there is no exit when you paint yourself into a corner.

It would be funny if it weren't devastating the lives of so many normal, sane, and decent working individuals and families.

I sure to hell hope we see a lot of hangings and executions by any means of the:  complicit corrupt crony class, duplicitious mealy-mouth equivocating back-stabbing politicians, and the avaricious greed mongering money-changers.

Wed, 04/22/2015 - 21:18 | 6020498 Yen Cross
Yen Cross's picture

 At least I got out of my stale aud/jpy short position. The farking buy side is testing the stops down to .7710/20 in aud/usd.

 Come on ya big boys, bang my orders.  Yaah hooey, I'm hedged.

 There's this really ugly H/S pattern forming on usd/jpy h-4.

 

Wed, 04/22/2015 - 21:40 | 6020557 Soul Glow
Soul Glow's picture

Day trading makes me manic.  I'd rather be farming 8)

Wed, 04/22/2015 - 21:44 | 6020567 Yen Cross
Yen Cross's picture

  I have multiple trades on various "time frames" open S/G.

  Be short $usd going into the New Home sales# . ;-)  I enjoy your contributions @Z/H

Wed, 04/22/2015 - 21:58 | 6020615 Omega_Man
Omega_Man's picture

stocks are the true hedge against inflation... but sell at the top

Wed, 04/22/2015 - 22:02 | 6020632 Seal
Seal's picture

Japan transforms itself by calling to itself sudden disasters such as Pearl Harbor and Hiroshima. This is no different. 

Wed, 04/22/2015 - 22:22 | 6020679 mrcgunderson
mrcgunderson's picture

What would happen if the central bank were to forgive the debt?  

Thu, 04/23/2015 - 00:59 | 6020987 rex-lacrymarum
rex-lacrymarum's picture

This woulkd pose enormous technical problems, as in: what happens to the liablity side of the central bank's balance sheet? Ultimately it would likely destroy the currency

Wed, 04/22/2015 - 22:27 | 6020698 SheepDog-One
SheepDog-One's picture

He's just the first one to be honest about it, QE is like a cancer once started it can't stop until everything is dead.

Wed, 04/22/2015 - 22:43 | 6020733 Yen Cross
Yen Cross's picture

 If the BoJ continues on their pace of JGB purchases, they're going to run out of inventory.

 

Wed, 04/22/2015 - 22:45 | 6020746 Paracelsus
Paracelsus's picture

There will be a crowd of pissed off Japanese retirees when they are told their fund is broke.Sank it all into JGB's.Tokyo said to do it.

Reminds me of the ECB ordering the Cyprus banks to load up on Greek bonds.

High risk/High yield     Low risk/Low yield

Sovereign debt = Very low yield/incredible risk of default

Next up,USA student loan debt and muni bonds.

Oh,isn't there a huge fund in the US which is heavy into Puerto Rico?

Damn this thing is getting exciting as it winds down the gurgler.

Can't wait to see these school kids when their phones don't work....

Thu, 04/23/2015 - 02:34 | 6021073 papa_lazarou
papa_lazarou's picture

None of this BOJ QQE bullshit and Morgan Stanley "economic team" gibberish matters.

When America launches its war against Russia/China/North Korea, Japan will be the sacrificial lamb on the altar.

Look for a false flag in the form of a nuke.

Before the Japanese government is able to default on its debt, Tokyo will be wiped off the map in the first salvo of the next (final?) world war.

Thu, 04/23/2015 - 03:30 | 6021113 bentaxle
bentaxle's picture

Thank god foreigners (only Japanese nationals) don't own any JOY debt!

 

 

 

 

Sarc

Thu, 04/23/2015 - 04:01 | 6021127 Debugas
Debugas's picture

when one can print to infinity there is no market discovery mechanism but a casino

So the government issues bonds the BOJ issues yen, they exchange it with each other. some 3rd parties play this casino.

Any rational person would not touch these

 

Thu, 04/23/2015 - 05:15 | 6021157 basho
basho's picture

what's going to do japan in, QE or Fukushima.

a race into oblivion.

such a proud people

FUBARed

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