It doesn't take an Econ Ph.D to realize that what Japan is trying to do: which is to recreate the US monetary experiment of the past four years, which has had rising stocks and bonds at the same time, the first due to the Fed's endless monetary injections (and pent up inflation expectations) and the second due to quality collateral mismatch and scarcity and shadow bank system funding via reserve currency "deposit-like" instruments such as TSYs, is a problem. After all, those who understand that the BOJ is merely taking hints from the Fed all along the way, have been warning about just that, and also warning that once the dam breaks, and if (or when) there is a massive rotation out of bonds into stocks, it is the Japanese banks - levered to the gills with trillions of JGBs - that will crack first.
Apparently, this elementary finance 101 logic has finally trickled down to the BOJ, whose minutes over the weekend revealed that members are pointing out "contradictions" in the Kuroda-stated intent of doubling the monetary base in two years, unleashing inflation, sending the stock market soaring, all the while pressuring bondholders to not sell their bonds.
As the FT reports [17], "According to the minutes of the April 26 policy meeting, released on Monday, a “few” board members said the BoJ’s original stance “might initially have been perceived by market participants as contradictory”, causing “fluctuations in financial markets”.
More on Mrs. Watanabe's confusion from the FT [17]:
After Haruhiko Kuroda’s first meeting as BoJ governor on April 4, the bank said it would lower interest rates across the yield curve, thus pushing investors into riskier assets such as loans and stocks. At the same time, it said it aimed to achieve a 2 per cent rate of inflation at the earliest possible opportunity – implying upward pressure on rates.
Since then, prices of bonds have slumped amid record levels of volatility, as traders have struggled to adjust portfolios in light of what some called the “Kuroda shock”.
Kazuhiko Sano, chief strategist at Tokai Tokyo Financial Holdings, said investors are “very confused”, adding that “many are reluctant to buy bonds right now”.
Which is why tomorrow, the BOJ has no choice but to "explain" to banks that they must all hang in there and nobody must sell JGBs, or everyone drowns at the same time: "the BoJ plans to hold a meeting on Wednesday with traders of Japanese government bonds to discuss ways to fine-tune its bond-buying operations." Expect the BOJ to be quite persuasive in forcing yet more capital misallocation. Why? Because as we first showed over a week ago, according to the BOJ itself, a 100bp (parallel) rise in market yields would lead to mark-to-market (MTM) losses of 20% of Tier-1 capital for regional banks and 10% for the major banks. And, as we added, "he who sells first wins..." We already got a first instance of panic dumping last week when the 10 Year JGB hit 1% and when the stock market crashed. How long until the second case of first selling? Indeed, the BOJ is at least finally pointing out what has been obvious to most for years: "In its latest report on financial stability, published last month, the BoJ said that a “substantial” rise in JGB yields without any improvement in economic activity could weaken banks’ capital ratios, thus “affecting the resilience of the financial system and the real economy”."
Luckily, at least some at the BOJ realize just how idiotic such jawboning against logic is, perhaps those left over from the Shirakawa regime, who also understand that 2% inflation and soaring yields for a country with 240% debt/GDP is suicide:
Yet the comments from the BoJ board members revealed in the minutes are a sign of the “tensions” behind the united policy front, said Naka Matsuzawa, chief Japan bond strategist at Nomura.
Mr Matsuzawa said the BoJ was “chasing two rabbits at the same time”, alluding to the bank’s stated desire to lower nominal yields while pursuing a higher target for inflation, which implies a rise in interest rates.
“Eventually, the target is the same, to push up the economy. But en route, they are having contradictory implications for JGBs,” said Mr Matsuzawa.
While it is unclear how many BoJ board members have raised concerns about “contradictions”, Masaaki Kanno, chief economist at JPMorgan and a former BoJ official, said “a few” probably meant two in this instance.
In the meantime, that biggest threat to market stability - liquidity evaporation - has appeared in the world's second largest bond market:
After the April 4 announcement that the BoJ would increase its bond purchases to about Y7tn-8tn each month in an attempt to double Japan’s monetary base within about two years, liquidity within the JGB market has evaporated, sending yields soaring. Banks have raised their long-term prime lending rates to compensate, meaning that monetary conditions have tightened, rather than loosened, under the new governor.
Not only that, but as we showed [18] over the weekend, the number of repo fails involving JGBs has exploded. How long until the far smaller Japanese shadow market slams shut?
So what is the bottom line? Simple: more Fed copycatting, which means the arrival of the monthly POMO schedule:
Some analysts say the BoJ should make its actions more digestible by shifting to a system of daily purchases of Y300bn-Y400bn, rather than eight operations a month of about Y1tn each.
And instead of giving the market a couple of hours’ notice each time, the BoJ should supply a detailed schedule of its purchases a month in advance, they say, spelling out sizes and target maturities in a similar manner to the US Federal Reserve.
Bottom line: the BOJ's very credibility is now on the line:
Without better management of the world’s second-biggest bond market, nerves will remain fragile, said Shogo Fujita, chief Japanese bond strategist at Bank of America Merrill Lynch.
“The BoJ has to kill the volatility it has raised. [The governor’s] credibility is at stake, right now.”
And since for the voodoo priests of monetarist, Keynesian policy, credibility, i.e. faith in an artificial and failing fiat construct, is all that matters, they better not blow it, or as the former CEO of Alliance Bernstein warned last night, and despite the best wishes from Buba's Jens Weidmann, Kuroda's experiment will be short if very violent one.