Kuroda Twist Seen as BOJ’s Duration Still Lags Fed: Japan CreditMariko Ishikawa, Andy Sharp and Shigeki Nozawa
Bank of Japan Governor Haruhiko Kuroda would need to both buy more longer bonds and cut shorter notes should the authority decide to quickly bring the maturity of its holdings in line with the Federal Reserve.
The BOJ’s plan to double the monetary base through debt purchases will only lengthen the average duration of its government bond holdings to 4 years by the end of this year from 3.5 years previously, according to calculations by Tokyo-based Japan Macro Advisors. That’s way below the Fed’s duration of about nine years.
“There’s room to flatten out the yield curve even more,” said Takuji Okubo, the managing director and chief economist in Tokyo at Japan Macro Advisors, who has previously worked at banks including Goldman Sachs Group Inc. “Something will happen in the next 12 months that will make the Bank of Japan ease the economy further. The answer has to be a twist operation.”
Kuroda said last week he’s ready to do more after his board decided to double monthly bond purchases and buy longer-maturity debt, in the nation’s biggest round of quantitative easing. A complete reversal of his predecessor’s focus on buying shorter notes would slash costs of home buying and other longer investments, while eroding profit margins at banks and robbing them of an incentive to lend.
The 10-year bond yield closed at 0.46 percent on April 5, when it touched 0.315 percent, the lowest on record. The 30-year yield also dropped to a record low 0.925 percent, narrowing its spread over five-year notes to 104 basis points, or 1.04 percentage points, the least since December 2008.
The equivalent yield gap for U.S. Treasuries was 218 basis points, compared to 215 basis points on Sept. 21, 2011, when the Fed announced Operation Twist to put downward pressure on borrowing costs. After the twist program ended, it began a third round of quantitative easing, purchasing $85 billion of Treasury and mortgage debt every month.
The BOJ said last week it will buy 7.5 trillion yen ($76 billion) of bonds a month, a shift that Kuroda said will mean the bank is buying the equivalent of 70 percent of debt issued. That will extend the average maturity of the securities it purchases to seven years from about three years, according to the central bank.
Kuroda has said it’s questionable whether buying more short-term debt is an effective easing measure. The BOJ needs to flatten the so-called yield curve by buying longer-maturity assets, he said at a news conference on March 21.
The average duration of Japanese government bonds and bills held by the BOJ decreased to 2.6 years as of February from 3.2 years a year earlier, as the central bank boosted purchases of notes maturing in one year to three years, according to calculations by Japan Macro Advisors. Duration is an estimate of how much the price of a bond will change when interest rates rise or fall. Bonds with longer maturities typically have greater duration than shorter-term debt.
The central bank may increase buying of debt maturing in 10 years or more to 1.4 trillion yen a month from the planned 800 billion yen announced last week, according to SMBC Nikko Securities Inc.
“The BOJ doesn’t seem all that aggressive when you compare the duration of its bond holdings with that of the Fed,” said Makoto Noji, a Tokyo-based currency strategist at the unit of Japan’s second-biggest financial group by market value. “There’s plenty of room for yields on longer bonds to fall as the BOJ buys more.”
Elsewhere in Japan’s credit markets, Bridgestone Corp. and Sojitz Corp. hired banks for bond offerings.
Bridgestone, a Tokyo-based tiremaker, hired Daiwa Securities Group Inc. and SMBC Nikko Securities for a sale of three-year and five-year notes, according to a statement from Daiwa. Sojitz, a trading company based in Tokyo, hired Mitsubishi UFJ Morgan Stanley Securities Co., Daiwa and Mizuho Financial Group Inc. for an offering of four-year debt this month, according to Mitsubishi UFJ Morgan Stanley.
Japan’s corporate bonds have handed investors 1 percent this year, compared with a 3.3 percent return on the nation’s sovereign debt, according to Bank of America Merrill Lynch index data. Company notes worldwide have gained 1.4 percent.
The yen fell to 98.85 per dollar today, the weakest since June 2009. It has plunged 21 percent in the past six months, the worst performance among the 10 developed market currencies tracked by the Bloomberg Correlation Weighted Indexes.
The BOJ set a two-year horizon for its 2 percent inflation goal last week and said it was shifting its attention from the benchmark interest rate to the monetary base -- cash in circulation and the money that financial institutions have on deposit at the central bank. It predicts the measure will grow to 270 trillion yen by the end of 2014.
The central bank “temporarily suspended” its self-imposed bank-note rule to keep the value of its bond holdings below the amount of cash in circulation. Former Governor Masaaki Shirakawa warned of a surge in interest rates and inflation if there’s a perception the BOJ is financing government deficits, a phenomenon known as monetization.
“The central bank may be intervening too much in the government bond market,” said Junko Nishioka, chief economist at Royal Bank of Scotland Group Plc in Tokyo and a former BOJ official. “Liquidity in the market is more important for the BOJ than lowering nominal yields.”
Confidence in JGBs could “eventually waver” if a sustainable fiscal structure is not put into place, Moody’s Investors Service said in a report dated April 4. There are longer term risks in the BOJ’s new policy, the company said.
The 60-day historical volatility for prices on Japanese bonds maturing in 10 or more years surged to 7.59 percent, the highest since November 2010, according to data compiled by Bloomberg and European Federation of Financial Analysts Societies. About a month after the 10-year yield reached the then-record low of 0.43 percent on June 11 that year, it jumped to 1.4 percent. That was the only year from 1995 to 2012 that Japan’s bonds had an annual loss.
“The Bank of Japan’s intention is to make the long interest rates so low that the banks give up on holding them,” Japan Macro Advisors’ Okubo said in an interview on April 5. “They want the banks to sell long-dated bonds, so that when inflation happens and the long bonds collapse, banks won’t be hit by valuation losses. The Bank of Japan will take the hit.”
Domestic investors owned 91 percent of Japanese government bonds at the end December, with banks and other financial institutions holding a third of the total, according to data compiled by the BOJ. Japanese banks have been relying on returns from JGBs for profit as loan earnings decline.
“The BOJ’s stimulus expansion has tipped the demand-supply dynamics of the super-long debt market,” said Takafumi Yamawaki, Tokyo-based chief rates strategist at JPMorgan Chase & Co. “There will be severe tightness in the longer-term debt supply and investors will be too afraid to sell as the yields can drop sharply any time.”