Two days day after the BOJ unveiled its “QQE with Yield Curve Control” (but no fries), the sellside has had time to digest the central bank's latest proposal and the assessment, unlike that of Dan Loeb, is anything but glowing. In fact, it's downright "deplorable."
We start with Goldman, which as we reported two days ago, admitted not only that what the BOJ is launching is tantamount to a "stealth taper", but more disturbingly, has no idea just how the central bank will effectively control the yield curve:
"it is very unclear at this time exactly how the BOJ intends to “control” the yield curve in the future. Based only on the official statement, we think it is likely it will maintain the yield curve at more or less the current level for the time being. However, the question is how it will control the overall level and shape of the curve when financial and economic conditions change in the future. While the JGB market needs to take time to study the BOJ’s intentions, with interest rate movements lessening, we think the pricing function of interest rates as a mirror reflecting real economic and financial conditions will be increasingly lost."
Goldman was not the only one confused by what the BOJ unveiled: there was also Deutsche Bank, which tactfully said that it sees a "slight contradiction" in the policy.
In a note titled "It may be over for the BOJ", DB's George Saravelos writes that "by targeting nominal rates the BoJ is relinquishing control of real rates. This creates a policy asymmetry that becomes highly pro-cyclical. Consider a negative demand shock that raises demand for JGBs and depresses inflation expectations. The BoJ will end up reducing the amount of JGBs it buys and raising real rates. Consider the opposite: a huge fiscal stimulus from the government that puts upward pressure on yields: the BoJ would effectively monetize the debt raising inflation expectations even further. We worry that a self-fulfilling tightening is more likely than an easing in coming months."
Saravelos then notes the following:
During World War II, the Federal Reserve established yield targets on US treasuries to help finance the war effort. The yield targets evolved into an indirect financing of the US treasury that persisted throughout the 1950s. By shifting to a yield target, the central bank is indirectly shifting the onus of a “helicopter drop” to the government. This is certainly a positive. But by relinquishing its own power and willingness to act its influence is now being reduced. Until we see more convincing signs of a large and credible fiscal easing from the government the BoJ’s inflation target will lack credibility.
In other words, Kuroda assumes a steady-state equilibrium essentially in perpetuity. However, once the curve starts shifting substantially, either parallel-shifting or steepening (it flattened last night, despite the BOJ's "best intentions") the central bank would quickly lose control as its intervention would only exacerbate the underlying move. In practical terms, this means that DB remains "JPY bulls and continue to target a break below 100 in USD/JPY to 94 by the end of the year."
Chiming in the BOJ hate parade, was CLSA's traditional skeptic, Chris Wood, who also penned an appropriately titled piece "Kuroda's Last Stand", in which he also notes that Kuroda is now trapped, correctly observing that "this attempt to fix the price of ten year money represents a massive hostage to fortune since, in a world where bond markets sell off, the BoJ is committed to potentially unlimited balance sheet expansion to hold the 10-year JGB at 0%."
However, unlike Deutsche Bank, Wood reaches the exact opposite conclusion on what the Yen will do, saying that "this would be hugely yen bearish. It could also mark the loss of any lingering credibility that Kuroda still has left."
And just in case CLSA's dire assessment of the BOJ's latest lunacy was unclear, he brings it home in the following paragraph:
The above suggests that Kamikaze Kuroda’s disastrous flirtation with negative rates will not be expanded for now though for “face” reasons it has not been formally abandoned. Indeed the BoJ in a face-saving measure stated that one possible option for additional easing is to cut the short-term policy interest rate. Meanwhile the practical problem for Kuroda is that he remains way below his 2% inflation target which is why it is wrong to assume that there will be no more monetary policy fireworks in Japan. Indeed GREED & fear is still of the view that monetisation of infrastructure stimulus, as recommended by Ben Bernanke, is still on the table in Japan; though it is more likely to be announced once the situation in America becomes clearer following November’s US presidential election. It should be noted that Kuroda has already adopted one of Bernanke’s suggestions floated in his blogs in March and April, namely targeting of rates higher up the yield curve. He can therefore easily implement another. For such reasons GREED & fear would be a seller of the yen, rather than a buyer, on a 12-month view.
Finally, adding to the confusion over what happens to the Yen was Crossborder Capital's note, according to which the BOJ's curve shift announcement was the central bank's "Second Big Error" and shows "policy makers have little understanding of how the yield curve operates" adding that the "end result will be higher Japanese bond yields, a steeper yield curve and a stronger JPY."
If upward pressure on the 10-year note kicks in, and the BOJ makes good on its commitment to intervene, real term premia will in fact rise, since 20-year and 30-year yields will be pushed up as a result. In other words, the yield curve will be kinked: effectively flat up to 10 years but sharply steepening thereafter. The research firm concludes that central banks can't fix the shape of the yield curve "rather like squeezing a balloon full of air in one place [it] simply pushes out the balloon somewhere else."
In Crossborder's scathing attack on Kuroda, the reports also notes that the "BOJ controls policy rate not term premium" adding that "policy rate accounts for around 25% of yield curve variation, while term premia, outside of BOJ control, determine up to 75% of the variation." Which is why "if it cannot control three-quarters of movements at the long-end of the curve, the BOJ has barely any control over its overall slope." Repeating what Saravelos said above, the authors say that "trying to hold down 10Y yields, thus injecting more liquidity into markets, will likely push up 20Y and 30Y yields, resulting in a yield curve with negative convexity" and conclude that "BOJ policy will distort term structure, could strengthen JPY and will likely underscore need for even more fiscal support." In other words, the BOJ's attempt to control the BOJ's yield curve will fail, because "like squeezing a balloon full of air in one place, the BOJ simply pushes out the balloon somewhere else."
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Summarizing the above, when it comes even to sellside analysts, the BOJ has now lost credibility. Worse, when the time comes for the central bank to intervene in the yield curve - as it will have to, and as it has promised to - it will not only fail to do what it has promised, but its intervention will only makes the problem worse, and lead to the next stage of the global VaR-shocked, bond bubble-bursting stage.