The surge in Japanese long-term interest rates is likely causing some lost sleep among bond market participants and policymakers (despite their ignorance of the moves in the BoJ minutes) as Nomura's Richard Koo notes, if this trend continues (now added to by the collapse in stock prices) it could well mark the “beginning of the end” for the Japanese economy.
Although the stock market has (until now) welcomed the yen’s continued slide against the dollar, Koo warns that this trend needs to be carefully monitored, as simultaneous declines in JGBs and the yen can be interpreted as a loss of faith in the Japanese government and the Bank of Japan. The biggest concerns are that the extreme volatility in Japanese stocks and bonds is occurring at a time when the BOJ was buying large quantities of government bonds.
Until the recent events there was an expectation in the JGB market that bond prices would not fall substantially even if the Bank’s aggressive easing program depressed the yen and lifted inflation expectations as long as the BOJ remained a major buyer. It is now clear that even large-scale BOJ purchases of JGBs cannot stop yields from rising.
Via Richard Koo, Nomura,
The lies are working (too well)...
Mr. Kuroda’s psychological tactic of repeating a lie often enough that it becomes the truth has succeeded brilliantly.
The problem is that it works on lenders as well as on borrowers. Moreover, borrowers are agents in the real economy and need time to react, whereas lenders are financial sector entities that can respond instantaneously, creating the possibility that lenders will react sooner than borrowers.
The fact that the BOJ has also reversed the traditional order of things and is trying to spark an economic recovery by generating inflation has increased the possibility that higher long-term rates driven by inflation concerns will emerge sooner than higher long term rates rooted in a recovery in the real economy.
But that is leading to a 'bad' (uncontrollable) rise in rates...
If we refer to higher interest rates driven by an economic recovery as a “good” increase and higher rates sparked by inflation concerns as a “bad” increase, I think there is a significant possibility that the latter will emerge first in this case.
That would not only weigh heavily on the first shoots of private loan demand to arise in a long time but could also focus attention on the banks’ and the government’s financial health, damping the positive momentum in the economy and markets seen over the last four months.
This kind of contradiction in timing is called the “time inconsistency problem,” and it will continue to hang over the policies of the Kuroda BOJ.
Simply out, Koo's perspective is that the BoJ needs to rein itself in...
BOJ needs to declare it will not tolerate overshooting of inflation
What can the BOJ do? To begin with, the Bank and the government could make it clear that they are targeting a 2% rate of inflation but at the same time, they will not under any condition tolerate a significant overshooting of that rate.
By stating that they will not accept an overshooting of the target, the Bank of Japan and the government could reassure the markets that there will be no plunge in the yen and no bouts of uncontrollable inflation.