Just as the European 'markets' have entirely disconnected from fundamental reality, Japan's bond market - the largest in the world - "is dead, with only the BoJ driving prices," Mizuho warns. Crucially, once again just as in Europe, "these low yields are responsible for the lack of fiscal reform in the face of Japan’s worsening finances. Policy makers think they can keep borrowing without problems." Market functions are sacrificed for the sake of ending deflation, but "liquidity has evaporated as the BOJ has gobbled up most of the market." This means that a reduction in monetary stimulus could cause a rapid drop in bond prices, which, just as in the US, "will make it difficult for the BOJ to normalize policy." Simply put, as Bloomberg notes [8], the BoJ has killed the nation’s sovereign bond market, leaving it unable to reflect either the success of stimulus policies or fiscal risks.
Via Bloomberg, [8]
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Monthly trading of Japanese government bonds among the biggest holders including banks and insurers shrank to 37.9 trillion yen ($385 billion) last quarter, the least on record going back to 2004, according to Japan Securities Dealers Association data.
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“The JGB market is dead with only the BOJ driving bond prices,” said Tetsuya Miura, the chief bond strategist at Tokyo-based Mizuho, one of the 23 primary dealers obliged to bid at government auctions. “These low yields are responsible for the lack of fiscal reform in the face of Japan’s worsening finances. Policy makers think they can keep borrowing without problems.”
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Japan’s government has yet to present detailed proposals on how to consolidate its finances, the International Monetary Fund said last month.
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The central bank said last week the country is on track to hit its 2 percent inflation target. Prices excluding fresh food are projected to rise 1.3 percent in the year from April, the BOJ expects, after accounting for the effect of the sales-tax increase.
Higher costs of living typically erode real yields, or what bondholders earn after inflation, damping the appeal of the currency needed to buy them. The difference between 10-year JGB yields and the most recent inflation rate in Tokyo was about 0.3 percentage point, near the lowest since December 2008.
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“The BOJ’s priority is to lower Japan’s real interest rates and ensure an end to deflation, even if they have to sacrifice liquidity and trading volumes in the bond market,”
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“Market functions are sacrificed for the sake of ending deflation,” said Izuru Kato, the Tokyo-based president of Totan, a research unit of money-market broker Tokyo Tanshi Co. A reduction in monetary stimulus could cause a drop in bond prices, which “will make it difficult for the BOJ to normalize policy,” he said.
Such a risk has already been seen in the U.S.,
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“Liquidity has evaporated as the BOJ has gobbled up most of the market,” Nicholas Spiro, the London-based managing director of Spiro Sovereign Strategy, wrote in an e-mail. “To all intents and purposes, there is no JGB market.”