The $9 trillion market for Japanese government bonds had been all
but paralyzed since the BOJ began a massive monetary easing three
years ago that made the bank the dominant buyer.
But in the two months since the BOJ announced it was imposing a
negative interest rate, JGBs have become a volatile commodity, with
prices swinging wildly as below-zero yields confound investors'
attempts to find fair market value.
"The JGB market is really in a bubble, when you think about it as an
investment vehicle," said Takuji Okubo, chief economist at Japan
Macro Advisors in Tokyo. "Their prices have moved away from
fundamentals, and people don't have a traditional way to measure
As the BOJ's dominance distorts bond market functions and dries up
liquidity, the central bank could have a hard time tapering its
buying binge when it eventually chooses to exit its "quantitative
and qualitative easing" program.
The bank theoretically could just sit on its enormous holdings until
the bonds mature, but policymakers are unlikely to want those assets
to remain on the balance sheet for decades. On the other hand, it
might be difficult to smoothly taper off its asset purchases, much
less sell its holdings.
So far, the BOJ's money printing has kept the cost for financing the
government's massive public debt very low. A spike in that cost
could stoke market fears Japan may be losing control of its
finances, potentially triggering a damaging bond sell-off, some
"It would be quite tough for the BOJ to taper such an enormous
balance sheet without disrupting markets," said a person familiar
with the BOJ's thinking.
In the meantime, buying bonds that yield less than nothing is
creating losses for the exchange-listed BOJ - not an immediate worry
for the government but a potential risk to confidence in the
guardian of the yen.
"The BOJ is sitting on a lot of risk, taking a huge position," said
one fund manager who declined to be named due to the sensitivity of
the matter. "How long can they keep buying so many JGBs? Not
forever, but a long time."
BOJ officials publicly say the slide in bond yields into negative
territory showed the Jan 29 move to adopt negative rates was
effective in pushing down borrowing costs, and that volatility will
fall as market players get used to the concept of negative rates.
But some BOJ officials worry that bond yields have become more
susceptible to abrupt swings as speculators and newcomers to the
market hoard 10- and 20-year JGBs, without much consideration to the
risks and term premium.
As a result, the BOJ - which the International Monetary Fund says is
reaching the limits of the amount of debt it can swallow - could
face difficulties if it wants to expand its asset purchases, as
markets expect it will.
"If investors are buying long-dated JGBs just because they yield
something, they may be under-estimating the risks," said another
official familiar with the BOJ's thinking.
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"The BOJ needs to conduct market operations so that markets don't
become excessively volatile," the official said.
With the market dominated by the BOJ's massive buying and its policy
decisions bent on surprising markets, many market players expect
high volatility to persist, giving Japanese investors who still hold
a large amount of JGBs a headache.
Negative yields make it a challenge to calculate a bond's fair
value, the returns it can be expected to generate through maturity.
Market participants say wide spreads between bids and offers also
complicate trading, and increase volatility.
The average daily trading range of the benchmark JGB futures rose to
about 0.44 point after the BOJ's shock decision to adopt negative
interest rates, more than double the average of 0.20 point in the
preceding one-year period.
Trading in longer-dated cash bonds became even messier as about
three quarters of JGBs, or up to 12 years to maturity, have negative
yields, prompting investors to rush to buy 20- and30-year bonds in
"As investors fight to secure some of the rapidly declining float of
investable bonds, the market is trading like a department store's
going-out-of-business sale," said Neale Vincent, strategist at
But many market players say the BOJ's unpredictable policy is the
biggest source of volatility.
The central bank announced its negative rates policy only days after
Governor Haruhiko Kuroda repeated his stance that negative rates
were not among its options - leading to cynicism in the market that
there was little point trying to forecast what the bank might do.
In addition, with zero percent no longer serving as a floor for
various interest rates, traders and investors are unsure how far
rates can fall, leading to unusual instability at the short end.
BOJ officials say they do not intend to control interest rates
because their main policy target is still base money, or cash and
deposits. But they cannot turn a blind eye to wild swings in
interest rates, particularly a spike in rates.
(Additional reporting by Shinichi Saoshiro and Hideyuki Sano;
Editing by Raju Gopalakrishnan)
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