Who’s Boss

I’ve talked quite a bit recently about central banks’ power over markets, and especially their own sovereign bond markets.

This is the subject of vociferous debate as policymakers in advanced economies don MMT lenses and feign surprise when they “discover” that currency-issuing governments with sufficient monetary sovereignty aren’t fiscally constrained.

If you insist on clinging to outdated notions around federal government financing, we can just say that the pandemic compelled officials in developed markets to admit that in the short-term, fiscal constraints are self-imposed — prisons that exist only in the minds of politicians, who will tear them down in the event of a catastrophe like COVID, even as they promise to wall themselves in again later. Rishi Sunak can tell you all about this.

While the long-term ramifications can (and should!) be debated, there is no debate about the capacity of developed market economies to engage in these types of policies over the very near-term. The last year has seen every major economy deliver twin accommodation, where fiscal stimulus is enabled by central banks.

Now, with the world (hopefully) emerging from the pandemic, some are keen to suggest that policymakers will “lose control.” As a quick aside, note that critics almost never define that phrase. “Lose control” is a kind of catch-all for everything from Venezuela-style hyperinflation to bouts of bear steepening in the curve. Ask a portal or a pundit who traffics frequently in “lose control” narratives to give you a concise definition of that phrase. And tell them they have to define it in a dozen words or less. They won’t be able to do it.

When it comes to monetary policy and bond yields, last week’s tantrum and especially the RBA’s trials and tribulations, led some to ponder the prospect of an imminent vigilante “victory.” As if, after all these years, central banks would suddenly give up in the face of rising yields. As if, after all this time and tens of trillions spent stamping out dissent, policymakers would inexplicably cede the castle.

Well, in a testament to how much sway at least one central bank still holds, consider that on Friday, Haruhiko Kuroda dispensed a little pain simply by opening his mouth. The market has been keen to speculate that the BOJ’s policy review could result in a widening of the trading band for 10-year yields. But on Friday, during an exchange with a lawmaker in parliament, Kuroda said he doesn’t think that’s “necessary.” Specifically, he said it was neither appropriate nor necessary to expand the band.

“Traders looking for pain trades in bonds this week may not have put Japan at the top of the list, but there’s an impressive one breaking out right now in JGB futures,” Bloomberg’s Mark Cranfield wrote, as a squeeze was unfolding during Asian trading. “Governor Kuroda decided to remind traders who’s boss,” he added.

In the current environment, tipping a widening of the band could have been destabilizing, so it’s not exactly surprising that Kuroda chose not to say anything that might have triggered a further backup in DM bond yields. But his remarks seemed pretty definitive considering the proximity of the bank’s next meeting and the conclusion of the policy review.

Some analysts were seemingly taken aback. A smattering of Friday commentary found BOJ watchers struggling to reconcile forecasts for a widening of the band with Kuroda.

The BOJ has gone further than anyone when it comes to cornering the market for the debt of their sovereign. What happened Friday was a rather stark reminder of the potential to be cut off at the knees by the folks with the printing presses.

As Bloomberg put it in a short article, “in just a matter of hours, Kuroda killed a trade that has been building for weeks.”