Bond Yields Surge In Japan As BoJ Is Reminded Of Just How Fragile The JGB Market Truly Is

If you were looking for an added wrinkle in the increasingly complex market narrative, look no further than the usually predictable Bank of Japan.

Late last week, a JiJi newswire story tipped a possible change in the BoJ’s thinking on yield curve control and it caught the market’s attention. Specifically, the story suggested that Kuroda and co. are all set to “investigate” how they might go about ameliorating the deleterious effect of YCC on JGB volumes and bank profitability.

Liquidity in the JGB market has become famously thin (you might recall that on some days, the market is completely lifeless) and as for the effect on banks, have a look at this chart from Barclays:

The bank meets next on July 31, and in light of the JiJi story, markets will be especially keen to watch for any sign that Kuroda is thinking about tweaking something.

“BoJ Policy Board members have increasingly remarked on the side-effects of prolonged YCC since BoJ Governor Kuroda touched on the notion of a ‘reversal rate’ in a speech at the University of Zurich on 13 November 2017”, Barclays wrote, in a note dated Friday, adding that “BoJ Deputy Governor Amamiya, who might be expected to lead an eventual move toward normalization, and Policy Board member Sakurai, who was previously thought to have reflationist leanings, have commented on such side-effects”.

Of course the worry here is always the same for the BoJ. Any hint that they’re thinking of normalizing risks catalyzing bouts of yen strength and depending on market conditions, the currency’s safe haven status could potentially supercharge that dynamic.

Back in January, the yen reacted violently to an ostensibly routine paring of 10-25Y purchases.

You might recall that those reductions in purchases have laid bare a rather vexing issue for the BoJ as it ponders how (or even if) it’s possible to exit accommodation. The problem is that despite the so-called “stealth taper” being part and parcel of YCC (see chart from Goldman below), the FX market is still prone to overinterpretation when it comes to these rinban ops.

That tendency to overinterpret manifested itself in outsized moves in the yen earlier this year, a highly undesirable scenario as a stronger yen undermines the inflation targeting effort. In short: the sensitivity of the yen to slight tweaks in bond purchases suggests that any actual effort to normalize would be met with a significant (and potentially dangerous) FX reaction (i.e., yen rally).

That calculus was complicated immeasurably by the reemergence of the Moritomo fiasco, as any threat to Abe is seen as a threat to Abenomics which is in turn seen as a threat to the persistence of the BoJ’s easing efforts and thus yen positive.

That’s the backdrop and, again, the point is simply that any tweak to policy out of the BoJ is prone to triggering outsized market reactions.

Well, on Monday, 10Y JGB yields exploded higher by as much as 6bps as part of the ongoing reaction to the JiJi story:

That’s the highest in more than five months:

Subsequently, the BoJ conducted a fixed-rate purchase op for the first time since February, offering to buy 10-year JGBs at 0.11%.

This is especially interesting coming as it does amid the dollar weakness catalyzed by Trump’s criticism of Fed policy late last week.

USDJPY is down again to start the week and is now trading near its lowest since early this month. Here’s an annotated chart:

Through it all, it seems unlikely that the BoJ would surprise markets too much later this month. Again, the fact that the yen is a safe haven asset complicates this as does the fact that the JGB market is so illiquid.

“It’s a bit too premature to think that the BOJ will change its monetary policy in a big way,” SMBC Nikko Securities’ Hidenori Suezawa said on Monday.

Right. And if this year has taught Kuroda anything, it’s that even innocuous statements can lead to “undesirable” market outcomes that force clarifications.

Asked for comment about the “rumors” while in Buenos Aires for the G-20 summit over the weekend, Kuroda said simply this:

I know absolutely nothing about the basis for those reports.