At the pace the central bank is purchasing government bonds, Japan’s sovereign debt market will be extinct by 2027.
The ¥616 trillion of JGBs now available to markets would shrink by about ¥52 trillion a year under current policies, making all of the securities either owned by the Bank of Japan or redeemed by the government by March 2027, data compiled by Bloomberg show. While it is unlikely the central bank will keep up net purchases of ¥80 trillion annually and it is hypothetical to assume issuance stays at ¥126.4 trillion every fiscal year, BNP Paribas SA says the threat to the market’s proper functioning is real.
“The JGB market is nearly extinct thanks to the BOJ’s aggressive stimulus,” said Ryutaro Kono, chief Japan economist in Tokyo at BNP Paribas. “Yield curves are extremely important as the sovereign debt market is the core of a country’s financial market.”
The BOJ’s policy has so far failed to boost inflation expectations to its 2 percent target, forcing policy makers to accelerate bond buying and cutting yields up to five years below zero percent last month. Historical volatility on JGBs jumped to the highest since April 2013 on Feb. 3 as yields rebounded. Primary dealers charged with making a market in bonds told the government last year that declining activity is making it hard to determine the proper prices.
While the government plans to cap new issuance of debt below ¥40 trillion, the BOJ expanded its annual purchases to ¥80 trillion in October.
“If the BOJ continues to ease at its current pace until 2020 when Tokyo hosts the Olympics, its ownership of outstanding JGBs would exceed 50 percent,” said Akio Kato, the Tokyo-based general manager of the trading department at Kokusai Asset Management Co. “When the share exceeds 40-50 percent, it threatens market mechanism or soundness. They may continue for another two years or so, but I’m not sure if they will for the next five to six years.”
The trading volume among the nation’s largest banks, trust banks and insurance companies dropped to ¥22.7 trillion in December, the least on record dating back to 2004, according to Japan Securities Dealers Association data.
Financial institutions must hold a certain amount of sovereign debt in their portfolio as collateral even as yields drop. That means demand for bonds the BOJ is seeking to buy may fall short even earlier than the 12-year horizon used in Bloomberg’s analysis, said Toru Suehiro, an economist at Mizuho Securities Co. in Tokyo.
“It’s not imminent but the market could reach its limit earlier than the calculations indicate,” Suehiro said. “If the limit is hit while the current policy is intact, markets will be thrown in to considerable confusion.”
Historical 10-day volatility for an index tracking Japanese government bonds with maturities over one year surged to 6 percent on Feb. 3, a figure that’s more than 10 times last year’s low of 0.5 percent in June.
“Recent market moves show these investors are refraining from holding bonds, which don’t offer returns matching risks,” said Takeo Okuhara, a senior fund manager in Tokyo at Daiwa SB Investments, which managed the equivalent of $42 billion in assets. “Rising volatility reduces risk tolerance.”
Primary dealers in a November meeting with the Finance Ministry cautioned that the BOJ’s bond purchases are “not normal” as liquidity dries up.
Kuroda said on Feb. 4 in parliament that he doesn’t think liquidity in the JGB market has declined particularly as a result of the central bank’s purchases and that the BOJ will continue easing until inflation is stable at 2 percent. The rate, excluding the effect of a sales-tax increase last April, was 0.5 percent in December.
BNP’s Kono said the central bank’s current policy will face a limit sooner or later as its ownership already exceeds 30 percent for some issues and would account for about 36 percent of 10-year JGBs by the end of this year. The BOJ held ¥210.55 trillion of sovereign notes at the end of January, according to its own data.
“There will no longer be a market when a single player holds a 40 percent share,” Kono said. “The BOJ will not be able to sustain the pace of expansion in the monetary base by around the middle of 2016.”