The volatility in the JGB market has been reduced somewhat since the turmoil in April and May. But that has not translated into better bond prices. While the JGB 10-year has backed off the 1% threshold, at around 0.85% – 0.90% the yield is still way above the low of 0.315% and the 0.55% on April 3 (the day QE-steroids was announced).

At the Bank of Japan, the Markets Operations Division (MOD), the BoJ equivalent to the Open Market Desk at the FRBNY, has been working overtime to curtail volatility by fine-tuning its market procedures. Not only has the division changed the manner in which it buys the JGB’s (buying in smaller lots) but also some of its tactics.

The MOD has initiated government bond purchases on the same day as the Japanese Ministry of Finance’s bond auctions, but does not count such measures as direct monetization since they end up at the BoJ through the intermediary process (also just like the Federal Reserve pretense). In addition, the BoJ is also offering below-market loans for one-year terms to finance “private” JGB purchases – what amounts to indirect, off-the-books repo.

So the BoJ has been forced to take some extraordinary or emergency measures to ensure its emergency QE measures did not totally disrupt the financial system in Japan and elsewhere. Again, the stated goal for QE is inflation, and thus the mechanism for that is non-idle cash. QE, among other psy-ops, is supposed to force “market” participants, banks in particular, out of the JGB market and into “risky” assets.

Except the Japanese banks have not been following the QE script. The first part of the equation, forcing banks out of JGB’s, worked all too well; thus the volatility as collateral disappeared into the BoJ QE “silo”. Japanese bank holdings of JGB’s fell in April and May to the lowest level since January 2011, a ¥15 trillion reduction (-14%).

But on the other side, banks also reduced their holdings in equities while at the same time increasing cash balances or “reserves” at the BoJ, by about ¥8.2 trillion (+33.6%).

It seems QE has similar characteristics regardless of nationality. Setting aside the rhetoric about improving bank liquidity and monetary conditions, QE is mostly about investor and public psychology. Unfortunately for central banks and their models, psychology is never a straightforward mathematical translation. That is why JGB volatility caught them completely unaware and unprepared.  It still remains to be seen whether the rest of Japan succumbs to the mentalists in Tokyo.

 

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