Traders expected another rollercoaster session for what has become the "fulcrum security" in the global bond market, Japanese Government Bonds, whose every move reverberates around the globe and has been responsible for much of the global steepening action in the past two weeks... and they were not disappointed.
It started off well enough: when yesterday's dramatic selloff in JGBs failed to resume off the bat, there was a brief short squeeze, followed by a few hours of stability which kept the yield around 0.12%.
Then just before midnight EDT, Japanese JGB futures tumbled and yields jumped following a 10Y JGB auction which was badly received by the market, and which despite a bid/cover in line with recent auctions, saw poor pricing with a tail of 0.12, which is the longest in two years; the market reaction was to send the yield sharply higher back to session highs of 0.135% around the level when yesterday Japanese market regulators called for a margin call.
At this point questions started swirling: will the BOJ let 10Y JGB yields continue rising, letting them reach the 0.20% (the level Kuroda hinted at in his press conference) or maybe above, or would he launch another fixed-rate "unlimited buying" operation?
The answer turned out to be neither, because just after 1am EDT, the Bank of Japan surprised the market by offering to buy 400BN yen of 5-10 year bonds in a Rinban open market operation, i.e. the Japanese equivalent of POMO, that was outside its regular schedule, as the benchmark 10-year yield continued its advance. Immediately, the 10-year yield erased its advance and slumped back to unchanged.
Needless to say, the demand was more than enough, and the BOJ announced that the operation to purchase 400BN yen received bids worth 1.27t yen. The BOJ also told Bloomberg after the operation that its offer to buy 5-10 year bonds outside its regular schedule on Thursday "was meant to meet its policy objective of keeping the 10-year yield at around zero percent."
Ok, fine, but why the flip-flop by the BOJ, and why did Kuroda pick to do an unscheduled "POMO" instead of calming the market with the far more forceful "fixed rate" operation?
According to Nomura, the central bank was faxed with two distinct issues: i) the BOJ wanted to wait until 10-year yields climbed to 0.2% before announcing a fixed-rate operation but ii) it needed to slow the pace of the increase so it held an unscheduled debt-purchase operation.
Had the BOJ held a fixed-rate operation at current yield levels, traditionally seen as a yield "red line" for the central bank, it would have risked narrowing the trading range again and undoing all the verbal guidance from the latest policy meeting, while waiting for the yield to reach 0.2% "may have been a bit reckless", said Nomura's Takenobu Nakashima.
In other words, Thursday’s move suggests the BOJ will avoid using fixed-rate operations until the yield reaches 0.2%, and until it reaches that level it may continue to use this auction-style buying.
Others agreed, and Daisuke Uno, chief strategist at Sumitomo Mitsui said that the Bank of Japan’s unusual bond buying is aimed at removing the fixed idea about operations.
"What the BOJ sees as side-effects of its policy include a decline in market function," he says by phone. "Today’s operation is probably meant to be like a rehabilitation to help the market regain its function given it has been in doldrums."
"The BOJ signals to the market that it still keeps the yield curve under its control but its grip has loosened a little bit" he added.
The last part was spot on, because while the BOJ managed to preserve control, it now has the market guessing not only as to the magnitude of the yield move it will allow, but the form of intervention it will launch: what happens if the BOJ reveals there are far more bids for its rinban than clear? Would it set off an avalanche of selling? Alternatively, what happens when the BOJ has to do a constant fixed-rate operation at 0.20% should panic selling emerge as Kuroda's control "loosens" a little more?
* * *
But what was most notable about Kuroda's intervention is that the BOJ purchased JGBs just over an hour after they were issued, and as Mizuho observed, "the BOJ is taking too much risk," as buying bonds on the day of an auction is usually seen as problematic: "Because the BOJ has said, in principle, it refrains from conducting purchase operations on the day of an auction, most people have thought the central bank wouldn’t do it" said Mizuho's senior market economic Toru Suehiro... and yet that's precisely what the BOJ did.
"Today’s operation leaves a question mark on the central bank’s communication with the market" he added.
Concluding ominous, he said that tonight's intervention "also brings the BOJ a step closer to financing fiscal deficits even though the central bank doesn’t directly buy bonds from the government."
Of course, monetization of fiscal deficits is how all of this ends, not just in Japan but everywhere.
For now, the good news is that the Japanese bond market remained under control -a bond market which now determines the bond yields from France to the US. But what about next time, and the time after that?
And finally, if this is the kind of drama that a simply move from 0.1% to 0.2% entails, what will happen if the BOJ truly normalizes and lets yields move freely?