Bank of Japan shields bonds from equity storm with steady buying

Amid a storm of volatility in Japanese stocks, the Bank of Japan has kept the bond market a pool of serenity.

The Nikkei Volatility Index surged to 48.99 on Aug. 26, the highest since the disasters of March 2011, and was at 31.92 on Tuesday.

Since China’s yuan devaluation last month, a similar gauge measuring fluctuations in Japanese government bond futures has averaged 2.69, below its one-year average of 2.90. Turnover in the JGB market last month dipped below the average over the past year, while Topix index volume surged to the highest in two years.

BOJ Gov. Haruhiko Kuroda passed on an opportunity to enliven the market on Tuesday when he stuck to record stimulus, keeping yields stable as he forecast a slowdown in emerging nations will end. Deutsche Bank AG’s Makoto Yamashita says that means bonds are unlikely to budge until monetary policy can be shifted.

“Even if stocks sold off 20 to 30 percent, the bond market will only care if that actually leads to more easing,” said Yamashita, the chief strategist in Tokyo at the German bank. “If the Bank of Japan drastically reduces its outlook on the economy or inflation we could see more easing, but for now we don’t have evidence that it will happen.”

The central bank kept a pledge to keep increasing the monetary base at an annual pace of ¥80 trillion on Tuesday, as forecast by 33 of 35 economists surveyed by Bloomberg.

Kuroda said following the decision that even though exports and production are flat due to the slowdown in emerging markets, there is no change to the BOJ’s view that the price trend is rising and the economy will gradually recover.

The tranquility in the bond market stands out when compared with its global peers. Since Aug. 11, one-month implied volatility on German bund futures has averaged at 6.14, above the past year’s average of 5.38, data compiled by Bloomberg show. The Bank of America Merrill Lynch’s MOVE Index, derived from over-the-counter options on U.S. Treasuries, has averaged 85.76 during the period, above its one-year rate of 79.71.

Even those moves outside of Japan are subdued when compared with previous bouts of uncertainty, such as the third quarter of 2011, according to Hajime Kitano, a Tokyo-based chief equity strategist at Barclays PLC. The deteriorating outlook then over Europe’s economy is similar to today’s anxiety over a slowdown in China, yet bonds are not moving much, he said.

“Back then, yields in the U.S. plunged 1 percent, but today, they’re hardly moving at all,” Kitano said. “The flight-to-quality energy that’s pushing yields lower is battling it out with the potential that interest rates might actually rise. As a result, bonds are going nowhere.”

Even on the off-chance that the Federal Reserve raises U.S. interest rates this week, Japanese bonds are unlikely to budge much for now, Deutsche Bank’s Yamashita said.

“If the U.S. lifts rates we might see a temporary increase in JGB yields, but we won’t see a sustained rise until the BOJ begins to consider tapering,” he said.

Investors exchanged 54.6 billion shares of companies in the Topix in August, the most since September 2013. Turnover of JGBs slumped to ¥662 trillion, below the one-year average of ¥668 trillion, according to the Japan Securities Dealers Association.

Traders of corporate debt are taking cues from the JGB market, with the Bank of America Merrill Lynch Japan Corporate Index at 137.83, just 0.1 percent higher than Aug. 10, the day before China devalued the yuan. Turnover in company bonds slumped to the lowest since 1999 with just ¥1.4 trillion worth of such securities exchanging hands last month, according to the JSDA. Over the past year, it has averaged ¥2.1 trillion a month.

The gap was also visible in Japanese options markets. Turnover in options on JGB futures totaled 81,196 in August, below the one-year average of 107,928, according to the Tokyo’s bourse data. Volume of options on Nikkei 225 Stock Average futures surged to 4.5 million last month, above the 3.5 million average for the past year.

For Resona Bank Ltd.’s Tokyo-based chief market strategist, Koichi Kurose, the disappearance of volatility in Japanese debt is an indication that the BOJ’s stimulus, which is driving it to buy almost every newly issued government bond, is beginning to erode the market’s core function of setting prices.

“Whether it’s stock prices, bond yields or currency rates, the market’s primary role is finding the price,” Kurose said. “But similar to what’s happened with the yen, which tumbled from ¥110 to ¥120 per dollar after the BOJ eased last year, it seems bonds won’t budge much” until the central bank makes a move, he said.