There’s trouble in Keynesian paradise.
Earlier this week we noted that economist (and former BOJ member) Yuri Okina has become concerned about the destabilization of the government bond market [10] occasioned by Japan’s move to monetize all of JGB gross issuance. At issue is a lack of liquidity which in turn inhibits price discovery and promotes volatility. We also noted that while this exact same dynamic is unfolding in the US (as shadow banking liquidity [11] dries up), Japan is probably the most vulnerable to violent swings in government bond yields:
What’s especially perturbing about this scenario, is that sapping liquidity from the market has the potential to create enormous volatility (as we saw on October 15 of last year when Treasurys staged a six standard deviation move in the space of a few hours), something the pot committed BOJ simply cannot afford lest the house of cards should come cascading down. In other words, if yields on JGBs become increasingly unwieldy because either traders lose confidence in the central bank’s ability to manage the ponzi or a lack of liquidity triggers excessive volatility (or both), it’s game over or, as BlackRock put it: “...the nightmare scenario would be a spike in JGB rates leading to a fiscal crisis.
We saw evidence of this just one day later when the monthly auction for JGB 10s was weak causing yields to jump. That same day, Abe adviser Etsuro Honda expressed further doubts about the utility of additional easing, saying (basically) that the BOJ should just quit while it’s ahead [12] (or while it’s not as far behind as it would be if continues to double and triple down on the ponzi scheme).
Today, courtesy of Takahide Kiuchi (who voted against the latest round of QE), we get perhaps the strongest rebuke of Kuroda-style easing yet, as the BOJ board member warns of “dire consequences” if the central bank continues to blatantly disregard the “side effects” of its policies.
What side effects you ask? Why, the very same illiquidity and volatility that we’ve been pounding the table on for years.
From Dow Jones:
Mr Kiuchi said if the bank continues with the current program, which absorbs nearly all of newly issued government debt, the market will see a drop in liquidity--the ease with which investors can buy or sell bonds when needed. Should liquidity fall, "there is a risk interest rates will rise sharply if some incident or event happens.” (ZH: We assume this “incident” or “event” is akin to the “accident” that the CFS predicted in its report on the steep decline of market financing)
"There is a possibility that (the BOJ) would suddenly become unable to buy" its targeted amounts of bonds through market operations, he said. That would call into question the future course of the bank's policy, possibly causing "considerable confusion" in the market, he said.
For his part, Kuroda called the notion that demand for JGBs would dry up “very unlikely.”
Kiuchi is also skeptical about the ability of further asset purchases to boost inflation and even went so far as to suggest that the BOJ’s prediction of 2% inflation by mid-2016 is nothing more than a fairytale. As the following chart shows, he is almost certainly correct as the central bank’s previous efforts haven’t had the best track record when it comes to changing inflation expectations…
[13]
[14]
...which is entirely consistent with what we’ve seen across the globe…
[15]
More from Kiuchi:
- TOO LATE TO COPE ONCE SIDE EFFECTS OF QQE EMERGE
- DIRE CONSEQUENCES IF IGNORE QQE SIDE EFFECTS
- TEMPORARY CPI DROP WOULDN'T AFFECT EXPECTATIONS MUCH
- QQE EFFECTS ARE DIMINISHING
...and from Reuters [16]:
The Bank of Japan should give itself more time to achieve its ambitious price target, board member Takahide Kiuchi said, warning that an appropriate level of inflation forJapan is currently lower than the bank's 2 percent target.
The remarks by Kiuchi, who has long been skeptical of the central bank's radical stimulus program, contrast with Governor Haruhiko Kuroda's conviction that Japan is on course to meet the inflation target during the year beginning in April.
Kiuchi repeated his calls for watering down the two-year timeframe for meeting the inflation target, warning that Japan will see prices rise only gradually given the economy's low growth potential.
"Inflation may reach 2 percent at some point in the future if, as hoped for, structural reforms progress and boost Japan's growth potential," the former market economist told business leaders in Maebashi, a city north of Tokyo, on Thursday.
"But it's important to guide policy based on the understanding that an appropriate level of inflation for Japan now is lower (than 2 percent)," he said.
* * *
We have long known that the BOJ has all but lost control in the market. Now, it would certainly appear that it is losing control of the narrative which, when one is playing a confidence game, is the worst thing that can happen.
