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Categorized | Capital Markets

Bank of Japan tests new firepower


Posted on November 17, 2016

The Bank of Japan has launched its first infinite bond tenders — promising to buy as many bonds as investors want to sell at a fixed price — asserting its new cap on the yield curve with unlimited firepower.

In what traders described as a “show of intolerance” at recent market moves, the BoJ offered to buy as many bonds as the market wanted to sell with between one and five years left to maturity. It did not bid for 10-year bonds, where it has capped the yield at 0 per cent.

The move by the central bank makes use of financial weaponry that the BoJ granted itself just eight weeks ago and was deployed far earlier than analysts had expected. On Tuesday, with global markets still adjusting to the implications of Donald Trump’s presidency and a bond rout under way, yields on the 10-year JGB closed above zero for the first time since February.

In September, the BoJ brought in a new policy of “yield curve control”, where instead of focusing on an asset purchase target of ¥80tn a year, it pledged to cap 10-year bond yields at “around 0 per cent”. That means buying as many bonds as investors want to sell at that level.

After the 10-year JGB yield turned positive earlier this week, traders had said that coming sessions would likely see the market testing the BoJ and how far it was prepared to go to assert its new policy. The BoJ’s actions on Thursday suggest it intends to play a cat-and-mouse game with markets, acting to control yields, but not offering certainty about when it will intervene or at what price.

The BoJ needed to show that it was not going to tolerate the situation, said Shuichi Ohsaki, Bank of America Merrill Lynch rates strategist. The central bank, he added, had probably decided to use the fixed-rate purchase operation rather than simply increasing its existing JGB purchasing operations because it sees the current volatility as a temporary phenomenon.

“The Bank of Japan’s purchase amount is already huge and they probably think that they are already doing enough to keep yields down once the Trump-related volatility goes away,” said Mr Ohsaki. “They would not want to increase their normal [purchasing] operation because it is harder to reduce it afterwards.”

To achieve its aim, the central bank offered to buy unlimited two-year bonds at a yield of minus 0.09 per cent and unlimited five-year bonds at a yield of minus 0.04 per cent. Those yields are slightly higher than where the market was trading on Wednesday.

As a result, the BoJ found no sellers and did not buy a single bond. Instead, the market recoiled, with yields falling across the short end of the yield curve. Two-year yields fell from minus 0.1 per cent to minus 0.15 per cent and five-year yields dipped to minus 0.08 per cent from minus 0.05 per cent.

Analysts said that Thursday’s action might represent the BoJ performing an experiment of its own to see how effective its fixed-price purchasing operation really is in case the global bond sell-off gathers momentum.

Traders noted that the yield on the 10-year note fell briefly back below zero during the afternoon session and the strong market reaction suggests the new policy could prove powerful.