"Let's just do it and see what happens. It should be fine"…
BOJ Unexpectedly Cuts Purchases of Super-Long Bonds by 10b Yen
— Walter White (@heisenbergrpt) September 21, 2018
On Friday, the Bank of Japan threw caution to the wind and cut purchases at the long end of the JGB curve. As the sarcastic tweet above suggests, it was an inherently risky move.
I meant to write something about this a couple of days ago, but it got lost in the fog of trade wars and was generally overshadowed (from a reader interest perspective anyway), by the Hong Kong dollar story.
In the simplest possible terms, the BoJ has found itself in an absurdly precarious position when it comes to policy normalization. The so-called “stealth taper” is part and parcel of YCC, so any tapering of bond purchases on top of what would be going on anyway has the potential to trigger outsized moves. This is complicated immeasurably by the yen’s safe haven status. If, for instance, a reduction of JGB purchases (“hawkish”) were to coincide with a bout of risk-off sentiment (JPY +), then you could get unwanted yen appreciation and that undermines the already fruitless inflation targeting effort.
As the BoJ learned on multiple occasions this year, the mere suggestion that policy tweaks are in the cards is enough to create turmoil, with the two most prominent examples coming in January and July, with the latter episode forcing the central bank to step in with three fixed-rate purchase ops in the short space of a week to cap yield rise ahead of the July policy meeting.
At that meeting, the BoJ did indeed tweak policy and one of those tweaks involved telling the market that more “upward and downward movement” in yields would be tolerated going forward. Long story short, the message didn’t seem to resonate; the JGB market quickly went back to sleep as though July never happened. Here’s the JGB VIX (note the spike in July and the subsequent collapse):
That uptick you see there on the far-right comes courtesy of Friday’s paring of super-long purchases. There’s no telling what they were trying to accomplish with that decision, but the predictable result was a spike in yields. Here’s an annotated 10Y chart:
And here’s the 30Y:
Fortunately for the BoJ, Abe’s victory (JPY -), risk-on sentiment (JPY -) and the fact that UST yields surged this week as well, all helped mute any appreciation pressure on the yen.
There’s a cottage industry for speculating on BoJ “strategy”, but the bottom line is that Friday’s news stokes worries about whether the central bank is trying to guide yields higher and those worries could conceivably contribute to further pressure on DM bonds and/or add fuel to any bear steepening impetus.
As ever, Kuroda would implore you to keep a positive attitude….
I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it’. Yes, what we need is a positive attitude and conviction.