The Bank of Japan will be forced to start tapering bond-buying stimulus as soon as a year from now as it runs out of willing sellers, says the nation’s top-rated analyst. The good news, he says, is yields will not jump.
That is because by then, even though the central bank will be buying fewer Japanese government bonds, it will have cornered around 43 percent of the market and the dearth of available JGBs will see any rise in 10-year yields draw investors, according to Mitsubishi UFJ Morgan Stanley Securities Co.’s Jun Ishii. It also ultimately means the BOJ will be able to fulfill its pledge to keep the 10-year yield pinned around zero, he says.
“They’re approaching the limit for bond purchases, and eventually they’ll have no choice but to take the leap into tapering,” Ishii said in an interview in Tokyo on Tuesday. “But even then, the magnitude of their existing bond holdings will continue to put downward pressure on yields, so they should be able to taper without a lot of volatility.”
Investors and analysts have been divided on what the BOJ’s decision to target a 10-year yield of zero percent really means and how policy makers will go about enforcing it. There has been more consensus on why a new approach is needed, after the asset-purchase program boosted the central bank’s bond holdings above ¥400 trillion for the first time, 36 percent of outstanding debt.
BOJ Gov. Haruhiko Kuroda has said the new framework aims to increase the flexibility and sustainability of monetary easing, while reiterating that he retains the ability to boost bond purchases or deepen the negative deposit rate.
Ishii, voted the No. 1 bond analyst in a Nikkei Veritas magazine poll of institutional investors for the third consecutive year in 2016, has been prescient in predicting even before the start of Kuroda’s monetary policy experiment in April 2013 that aggressive asset purchases will likely strangle supply. Two months before the expansion of quantitative and quantitative easing in October 2014, Ishii foresaw the risk that investors would hoard bonds to preserve income.
He was also a rarity in forecasting a potential cut to the deposit rate before the BOJ announced a negative interest-rate policy in January. However, he does not expect the monetary authority to lower the rate further, because of the chilly reception the policy got from the financial industry and the general public.
Japan’s 10-year yield will be anchored at zero, in a range of 0.1 percent to minus 0.1 percent, according to Ishii. The benchmark initially surged above zero for the first time since March after the BOJ announced its curve control policy on Sept. 21. It then pushed to a one-month low of minus 0.09 percent, and was at minus 0.06 percent Thursday morning in Tokyo.
Ishii says there is little danger that the yield will fall far from zero because of the BOJ’s new fixed-rate purchase facility. Whereas previously investors could buy bonds at any yield level and hope to sell them on to the central bank, now policy makers can effectively set a floor for yields below which the notes become unprofitable, he said.
The BOJ’s dominance of the bond market since Kuroda became governor is evident in the “negative risk premium” priced into the benchmark yield, which should be around 0.8 percent based on economic fundamentals, according to Ishii.
“We’re all just BOJ watchers now,” he said. “If yields turn positive, the market will get some life back. Until then, dealers like us will have to be content with monitoring whether or not there are BOJ operations on any given day, and then trying to capture whatever tiny profit we can.”
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