It’s by now no secret that the Bank Of Japan’s mammoth QE effort is creating distortions in the JGB market where the central bank is on a mission to monetize the entirety of gross issuance. A lack of liquidity (which three fourths of dealers [7] see but somehow Governor Kuroda does not) creates widening bid asks which in turn inhibits price discovery and creates volatility. As we’ve said on a number of occasions, this is very, very bad for the BoJ as a sustained spike in yields could quickly deteriorate into a fiscal crisis as the entire ponzi scheme collapses on itself (don’t take our word for it, BlackRock said [8] the same thing). Indeed it was just last week that JGBs suddenly collapsed [9] as yields blew out on surging Treasury yields and disappointing economic data.
But if you needed further proof that asset purchases are sapping liquidity, look no farther than the following chart from BofAML which shows bank JGB trading volume:
[10]
Here’s BofAML to elaborate:
A key indicator of that will be the trading activity of the city banks. Liquidity has become the hot topic after the BOJ's recent release of the results of its bond market survey and a working paper on JGB market liquidity, and the decline in city bank trading activity in the JGB market can also be seen as evidence of a decline in liquidity. The JSDA says that the city banks had a monthly trading volume in coupon JGBs of around ¥27trn up until the implementation of QQE in April 2013, but that dropped to a monthly average of ¥11.8trn in FY2013. Trading activity recovered in FY2014, and the monthly average trading volume was ¥24.7trn up until the BOJ expanded QQE in October. However, the monthly average dropped sharply again from November to around ¥7.5trn. When trading volumes decline, there can be a sharp increases in volatility. Although the city banks are unlikely to increase their JGB holdings when the new fiscal year begins, they are also unlikely to abandon the JGB market. We expect they will return to the market in some form, but the high level of volatility is keeping investors away, and the risk of further raising volatility should probably be a concern. There is a possibility that another additional easing or a change in policy by the BOJ would again increase the risks. On the other hand, one of the aims of QQE is to encourage investors to leave the JGB market and invest instead in loans and/or risk assets. The time may have come to seek a solution to the drop in liquidity that is a side effect of the BOJ's large-scale JGB purchases.
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Meanwhile:
- KURODA: BOJ EASING WON'T CONTINUE AIMLESSLY
