Government bonds are themselves becoming more illiquid, most particularly, as CLSA's Chris Wood notes, in a country like Japan where the Bank of Japan has been buying more than the net issuance. Monthly trading of JGBs by lenders and insurers has collapsed from a peak of ¥123tn in April 2012 to a record low of ¥15tn in May 2016.
This raises the pertinent issue of whether the Bank of Japan has reached the practical limit of its government buying programme in terms of its current purchase programme of ¥80tn relative to estimated annual JGB net new issuance of ¥34tn.
In this respect, the Japanese central bank has from a potentially monetisation standpoint always defended the integrity of its JGB purchase programme by stressing that it only buys JGBs in the secondary market, which means that the seller of the JGB to the BoJ forfeits a claim to that asset. This is contrasted to what would happen if the BoJ bought JGBs in the primary market on an open-ended basis.
Such a process would be highly inflationary and, sooner or later, would be viewed by the market as such.
And as Wood concludes, the next step is obvious...
This is why Japan, as well as America, is also a candidate for monetisation of infrastructure stimulus or for what Bernanke has called a “money-financed fiscal programme”, or what has been called in other quarters “overt monetary financing”. This is because Bank of Japan governor Haruhiko Kuroda is now looking for a new alternative form of monetary easing, given he has probably reached the practical limits of responsible JGB buying, as already discussed, while his initial move to impose negative rates in January led to the opposite market reaction than expected (ie, a stronger yen and a weaker stock market, see Figure 8) while also proving politically very unpopular. This probably explains why Kamikaze Kuroda has not expanded the negative rate policy further since January even though inflation and inflation expectations have moved in the opposite direction of what he has been targeting.
The latest data will make it harder for Kuroda to do nothing at the next BoJ policy meeting due to be held on 28-29 July given the stress he has put on monitoring inflation expectations. That is unless he just admits he has failed!
Given the unattractive options of buying still more JGBs or ETFs, or risking an undoubtedly unpopular expansion of negative rates, Kuroda and indeed Abe will be looking for a new approach. Monetisation of infrastructure stimulus may be the option.
Meanwhile, in an effort to calm potential concerns about the integrity of the fiscal budget central bankers implementing such a future monetisation of infrastructure spending will doubtless be at pains to describe the process as a “one off” though, as the ever theoretical Bernanke stated in his blog: "To have its full effect, the increase in the money supply must be perceived as permanent by the public."
a policy of “helicopter money” is only likely to work if it is done on an ongoing basis and in continuing and growing amounts. But at that point the risk of a policy mistake grows exponentially, in terms of a potentially destabilising pickup in inflation expectations and a related pickup in velocity.
The above discussion on how future experiments with unconventional policy could impact markets is far from theoretical since all the evidence is that central bankers are not prepared to acknowledge the overwhelming empirical evidence that their policies are not working and, indeed, are having the opposite effect of what is intended. Instead they remain obsessed with policy frameworks influenced by inflation targeting and monitoring inflation expectations. It is, therefore, critical for investors to focus on what could be the next version of the monetary laboratory experiment with the obvious catalyst for that turning point market realisation that the Federal Reserve is not going to be able to normalise monetary policy.
Source: CLSA's Greed & Fear