BOJ’s Bond Paralysis Seen Spreading Across Markets: Japan Credit

Jun 15, 2014 6:48 pm ET

June 16 (Bloomberg) -- The Bank of Japan’s unprecedented asset purchase program has released a creeping paralysis that is freezing government bond trading, constricting the yen to the tightest range on record and braking stock-market activity.

Historical price volatility on Japanese bonds slid to a 2 1/2-year low of 0.928 percent on June 11 and a lack of activity delayed the start of trading for four days last week. The yen has been in a 4.68-yen range since Jan. 1, the tightest since Japan ended currency controls four decades ago. Average trading on the Topix index is near its lowest level in 1 1/2 years.

Asset purchases have not only made BOJ Governor Haruhiko Kuroda the biggest player in Japan’s $9.6 trillion bond market, they have also given him the most leverage over currency and equity markets in the world’s third-largest economy. Kuroda last week refrained from either expanding or reducing monetary easing that drove the yen to its biggest annual loss in more than three decades, pushed yields to a record low and boosted the Topix index to its highest since 2008.

“All the markets have been quiet,” said Daisuke Uno, the Tokyo-based chief strategist at Sumitomo Mitsui Banking Corp. “We’ve already seen the BOJ dominance of JGBs since last year, but recently participants in currency and stock markets are also decreasing as those assets have traded in narrow ranges.”

One-month implied volatility in dollar-yen fell to 5.25 percent on June 9, the lowest in data going back to 1995. The 30-day moving average for trading volume on the Topix dropped to 1.87 billion shares on May 28, the least since December 2012.

Volume Slumps

Benchmark 10-year bonds failed to trade on April 14 for the first time since December 2000 and didn’t change hands during two morning sessions last week. The 12-month moving average of JGB trading of volume dropped to a record 39.6 trillion yen ($388 billion) in April, according to Japan Securities Dealers Association figures going back to September 2004.

“The flows on both the buying side and selling side continue to fall,” said Takehito Yoshino, the chief fund manager at Mizuho Trust & Banking Co., a unit of Japan’s third- biggest financial group by market value. “Falling volatility is a very serious problem for traders and dealers who are unable to get capital gains.”

Ten-year bonds yielded 0.6 percent last week, the lowest globally. The benchmark rate fell to an all-time low of 0.315 percent on April 5, 2013, the day after the BOJ unveiled record stimulus, before surging to 1 percent the following month.

Business Shrinks

“It’s difficult because the business is shrinking,” Hiroshi Kunimura, the director of fixed-income trading in Tokyo at Barclays Plc, one of the 23 primary dealers obliged to bid at government bond auctions. “Because we’re in an environment where traders take positions at auctions only to sell them at BOJ buying operations, trading volumes with investors struggle to increase.”

Kuroda on June 13 kept the BOJ’s pledge to accumulate 50 trillion yen of JGBs a year, equal to 42 percent of planned issuance for the fiscal year started April 1 in a bid to boost inflation to 2 percent.

Forty-two percent of economists forecast Japan’s central bank will expand monetary stimulus in October, which displaced July as the most popular pick for action, according to the Bloomberg survey conducted June 3-6.

Easing Expectations

Japan’s government bond market is becoming increasingly reliant on BOJ easing, leaving it vulnerable to shocks, according to Deutsche Securities Inc.

“Investors in Japan assume that the BOJ will continue to buy JGBs vigilantly next year and the year after,” said Makoto Yamashita, the chief Japan rates strategist at Deutsche Securities, a primary dealer. “They take it for granted they can sell those bonds bought expensively to the BOJ as more and more notes disappear from the secondary market. It’s too frightening to think what might happen when the BOJ tapers.”

Sumitomo Mitsui and Daiwa Securities Group Inc. said in April there’s no effective strategy in Japan’s low-yield, low- volatility environment.

Japan’s notes due in more than a year were the worst performers since Dec. 31 among the 26 debt markets tracked by Bloomberg and the European Federation of Financial Analysts Societies, gaining 1.2 percent. Government debt returned 2.9 percent in the U.S. and 4 percent in Germany.

“It’s sad how idle the JGB market is,” said Toru Yamamoto, a former trader for foreign bonds, derivatives who is now the chief strategist at Daiwa Securities Co. in Tokyo. “Coping with BOJ purchases is like running a marathon -- if it’s short-distance, you can still push yourself, but in a long run, you will run out of energy.”

--With assistance from Masaki Kondo in Singapore.