Not only has the Yen strengthened and stocks collapsed since BoJ's Kuroda descended into NIRP lunacy but, in a dramatic shift that threatens the entire transmission mechanism of negative-rate stimulus, Japanese banks (whether fearing counterparty risk or already over-burdened) have almost entirely stopped lending to one another. Confusion reigns everywhere in Japanese markets with short-term interest-rate swap spreads surging and bond market volatility spiking to 3 year highs (dragging gold with it).
As Bloomberg reports,
The outstanding balance of the interbank activity plunged 79 percent to a record low of 4.51 trillion yen ($40 billion) on Feb. 25 since Bank of Japan Governor Haruhiko Kuroda on Jan. 29 announced plans to charge interest on some lenders’ reserves at the monetary authority.
While Kuroda wants to lower the starting point of the yield curve to reduce borrowing costs and spur shift of funds into riskier assets, the interbank rate has fallen only about as far as minus 0.01 percent, above the minus 0.1 percent charged on some BOJ reserves. The swings on bond yields will make it harder for financial institutions to determine how much business risks they can take, weighing on lending in a weak economy even as they are penalized for keeping some of their money at the central bank.
It will take at least another month until the market finds a level where many dealings are settled, as financial institutions face uncertainty over how the new policy affects monthly fund flows, said Izuru Kato, the president of Totan Research Co. in Tokyo.
“Since past patterns don’t apply under the entirely new structure, financial institutions will take a conservative approach until the financing picture is nailed down,” Kato said. “If the funding estimate proves wrong, banks might lose by prematurely lending in negative rates. People are cautious and staying on the sidelines.”
All this chaos has sent risk premia surging everywhere you look in Japan:
Reflecting the confusion among traders about the unprecedented negative-rate policy, the one-month premium for one-year interest-rate swaps have surged, according to data compiled by Bloomberg.
“The swaption market is reacting to the heightening volatility because players don’t know where Libor will settle,” said Naoya Oshikubo, a rates strategist at Barclays Plc in Tokyo. “One reason behind this is the fact that unsecured overnight call rates and general collateral repo rates aren’t falling as intended by the BOJ.”
And as Japanese bond volatility surges, it seems demand for gold rises (as perhaps VaR restrictions of Japanese bank balance sheets force a rotation to relatively lower risk assets)...
And while the last week has seen a G20-Hope-fueled lull in the collapse,
“It is still uncertain how deep into the negative the overnight call rates will sink,” said Naomi Muguruma, a senior market economist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “It won’t settle until funding flows in the new scheme become clear. That may pressure volatility to stay high for government bonds.”
Simply put, “The focus will be how much money these institutions facing negative rates will lend out in the market,” or how little.