Negative Yields Show BOJ Set to Override Markets: Japan Credit

Japan’s investors are paying to lend to the government for the first time in at least five years, suggesting the central bank is willing to accept dysfunctional markets as the price for meeting its price goal.

The yield on bills maturing in six months dropped to a record low minus 0.001 percent on Sept. 9, according to Japan Bond Trading Co. Three-month securities became negative for the first time in secondary-market trading last week, according to data going back to at least 2009.

Bank of Japan Governor Haruhiko Kuroda signaled this month that more stimulus is possible to achieve a goal of 2 percent inflation, after a sales tax increase knocked the wind from a recovery in the world’s third-largest economy. The BOJ’s strategy of expanding cash in circulation plus bank reserves by as much as 70 trillion yen ($656 billion) annually via debt buying is showing strain as supplies dwindle and negative yields in Europe prompt overseas investors to chase the same notes.

“The current shortage of bills is so severe that even a small amount of purchase is likely to push yields to negative territory,” said Yusuke Ikawa, a rates strategist in Tokyo at UBS AG. “Even if the BOJ is able to meet the target for monetary base expansion this year, next year will be very challenging.”

The BOJ on Sept. 9 bought 500 billion yen of debt maturing in less than a year from the secondary market, including securities that yielded minus 0.004 percent the previous day. The average difference between the market yield on bills and the level at which the BOJ was offering to buy the securities was minus 0.006 percentage point, central bank data show.

Seigniorage Loss

Bill buying at a negative yield is “unprecedented,” because the BOJ takes a loss due to seigniorage -- the difference between the face value and the cost of issuance, according to SMBC Nikko Securities Inc. in Tokyo.

“The BOJ could have avoided buying at negative yields, but it chose not to,” Koya Miyamae, senior economist at SMBC Nikko, wrote in a report yesterday. “This underscores the BOJ’s determination to continue its record easing.”

The central bank increased JGB holdings to 178.6 trillion yen at the end of last month from a year ago and boosted bills by 33 percent, central bank data show. Policy makers have pledged to expand the monetary base to 270 trillion yen by the end of the year from 243.5 trillion yen at the end of August.

“I don’t think a negative yield would create an obstacle for buying operations,” BOJ Deputy Governor Kikuo Iwata told reporters at a briefing yesterday.

Tax Dilemma

Japan’s gross domestic product shrank an annualized 7.1 percent in the second quarter, the most since the first three months of 2009, the final reading from the Cabinet Office showed Sept. 8. Prime Minister Shinzo Abe’s cabinet, which raised the sales tax in April to 8 percent from 5 percent, will decide by the end of the year whether to increase the levy by another two percentage points in 2015.

The government and the central bank can address the economic setbacks from a sales tax increase, BOJ Governor Kuroda said on Sept. 4. The risks are higher if the levy is not raised, he said.

“Governor Kuroda is constructive on the sales tax increase and insists that the levy should be hiked even if the economy is weak,” said Akio Kato, the Tokyo-based general manager of the trading department at Kokusai Asset Management Co., which oversees the equivalent of about $34 billion in assets. “To me that sounds like he’s suggesting that he wouldn’t hesitate to support growth with additional easing.”

Seventy-four percent of the 31 economists surveyed by Bloomberg News on Aug. 25-29 forecast the BOJ will expand stimulus, with October the most likely timing. That is up from 68 percent in the previous poll.

Europe’s Push

The European Central Bank’s unprecedented easing is helping to lure investors to Japanese government notes. Foreigners bought a net 110 trillion yen of short-term government securities this year through July, the most for the period since 2004, according to Japan Securities Dealers Association data.

Yields on the two-year notes in Germany, Austria and seven other European counties dropped below zero last week after the ECB unexpectedly cut interest rates on Sept. 4. The equivalent Japanese government bond yield was at 0.07 percent yesterday.

Japan’s benchmark 10-year bonds yielded 0.56 percent, down 17 1/2 basis points this year. A basis point is 0.01 percentage point. The yen traded at 106.77 against the dollar as of 9:43 a.m. in Tokyo today, after reaching the weakest since 2008 at 106.89 yesterday. It gained 4.7 percent percent against the euro this year and traded at 138.98.

“The BOJ will probably continue buying bills to meet its monetary base target,” Maiko Noguchi, senior economist at Daiwa Securities Co. and a former central bank official, said in a seminar in Tokyo on Sept. 8. “But it’s difficult to continue Governor Kuroda’s unprecedented easing over the longer term. The BOJ’s exit strategy in the future becomes all the more difficult as its presence grows in various markets.”

Before it's here, it's on the Bloomberg Terminal.