BOJ Vet Sees JGB Rout If Abe’s Third Arrow Misses: Japan Credit

Investors will lose confidence in Japan’s economic revival unless Prime Minister Shinzo Abe adds substance to his growth strategy and relies less on stimulus measures, said a former senior central bank official.

“The situation will turn extremely dangerous if Abenomics doesn’t take a new direction,” Hideo Hayakawa, who previously served as executive director at the Bank of Japan, said in an interview in Tokyo on Oct. 15. Instead of laying the foundation for a sustained expansion, “Abe is just putting pressure on the BOJ to buy bonds and increasing fiscal spending by continuously compiling economic packages.”

The so-called third arrow of Abe’s economic strategy entered a key stage with the start this week of an extraordinary Diet session where he aims to push through measures to boost investment and industrial competitiveness. While the Topix Index of shares has soared 39 percent this year, government debt is more than double gross domestic product and the BOJ’s unprecedented easing is causing dangerous distortions in the bond market, according to Hayakawa.

“Much of the market is clearly numb to the risks,” said Hayakawa, now a senior executive fellow at the Fujitsu Research Institute. “Plainly stated, the situation in the government bond market is becoming considerably dangerous.”

Photographer: Scott Eells/Bloomberg

Shinzo Abe, Japan's prime minister. Close

Shinzo Abe, Japan's prime minister.

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Photographer: Scott Eells/Bloomberg

Shinzo Abe, Japan's prime minister.

The domestic bond market isn’t signaling any immediate signs of distress. The yield on the benchmark 10-year note was unchanged today after falling 2 1/2 basis points to 0.64 percent yesterday, the lowest level in the world for that maturity. After the BOJ announced record easing in April, the yield swung from a record low of 0.315 percent to as much as 1 percent in the next month.

Slow Headway

Abe dubbed the current parliament a “session for getting things done,” after his ruling coalition won July elections to end a hung parliament that had been in place since 2007. The session runs to Dec. 6.

Hayakawa said any progress in legislation probably won’t alter his view on the slow headway Abe is making in implementing his growth strategy. When Abe unveiled the plan in June, shares declined and the yen strengthened.

BOJ Governor Haruhiko Kuroda said in an Oct. 12 speech that the outlook for Japan’s economy is “perhaps brighter than at any other point since the turn of the century.”

The BOJ promised in April to double the monetary base, a gauge of the money supply, by the end of next year in a bid to meet a 2 percent price target in about two years. Core consumer prices, which exclude fresh food, rose 0.8 percent in August from a year earlier, the biggest gain since November 2008, led by higher energy prices and a weakening yen.

‘Fighting Pose’

The central bank today offered to buy 850 billion yen ($8.6 billion) of Japanese government bonds, the fifth such operation in October in purchases that total more than 7 trillion yen each month.

Etsuro Honda, an economic adviser to Abe, last week called on the BOJ to be ready to ease further. “I want the BOJ to constantly take a fighting pose as it takes time for the effects of monetary policy to be felt,” Honda said in an interview with Bloomberg News on Oct. 11.

Hayakawa’s concerns about the bond market were echoed by International Monetary Fund Deputy Managing Director Naoyuki Shinohara, who said in Washington last week it would be dangerous for the BOJ to add to its easing before Abe implements structural reforms, as it could give the impression that the central bank is financing government deficits.

“It would be too risky for the BOJ to buy more Japanese government bonds” when it becomes clear that the central bank’s inflation target isn’t possible, Hayakawa said. “It’s better for Governor Kuroda to urge more explicitly the need for fiscal consolidation,” he said.

‘Broken Thermometer’

Former BOJ board member Atsushi Mizuno on Oct. 2 called the JGB market a ’’broken thermometer,’’ saying that it doesn’t reflect concerns about Japan’s debt load or the economy due to distortions caused by the BOJ’s purchases.

Demand rose at a sale of five-year JGBs yesterday, signaling faith in the central bank’s backstop. Investors bid for 4.8 times the 2.7 trillion yen of notes auctioned, an increase from the so-called bid-to-cover ratio of 3.3 last month and the 10-sale average of 3.8.

A lack of detailed plans for deficit reduction in Japan and the U.S. combined with weak economic growth run counter to efforts to cut the global debt burden, the IMF said in its Fiscal Monitor report released on Oct. 9. Japan’s debt will expand to 243.5 percent of GDP this year, more than double the 106 percent level in the U.S., according to the report.

Spending Packages

Abe’s government will compile a 5 trillion yen economic package in December to offset damage from an increase in the sales tax in April to 8 percent from 5 percent today. Hayakawa predicted Abe may resort to additional fiscal stimulus if the tax is raised to 10 percent as planned in October 2015. Abe unveiled 10.3 trillion yen in fiscal spending in January.

Citigroup Inc.’s Surprise Index for Japan has dropped to minus 26.6 since peaking at a record 91.7 in July, signaling economic figures have increasingly fallen short of analyst estimates. While a similar gauge for Group of 10 nations has also slid since September, was at a positive 18.8 as of Oct. 15.

Historical price volatility of JGBs touched 1.58 percent this month, the lowest since February and compared with a five-year high of 3.98 percent in June, according to data compiled by Bloomberg. The BOJ is scheduled to release its forecasts on economic growth and inflation on Oct. 31.

“Bond yields are staying at these lows because of investor expectations that policy makers will struggle to end deflation,” said Makoto Suzuki, a senior bond strategist in Tokyo at Okasan Securities Co., one of the 23 primary dealers obliged to bid at government debt auctions. “Powerful bond buying by the BOJ as well as market consensus that yields won’t rise are contributing to low volatility.”

To contact the reporters on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net; Masahiro Hidaka in Tokyo at mhidaka@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

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