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Bank of Japan in a fix as bond market regains animal spirits

Central bank seeks to avoid sparking 'Kuroda tantrum' at next meeting

Gov. Haruhiko Kuroda wants to dampen recent speculation about changes to rate controls at the Bank of Japan's meeting next week.   © Reuters

TOKYO -- It was shortly after 7 p.m. on July 20 when Naka Matsuzawa, Nomura Securities' chief rates strategist in Tokyo, received a startling email from a colleague at the brokerage's London branch.

A flurry of news reports that Friday evening had suggested a possible tweak to the Bank of Japan's interest rate targets, citing sources familiar with preliminary discussions.

"Are we covered?" the London-based sales manager of Japanese government bonds asked.

A turbulent week was to follow.

After receiving the news that evening, Matsuzawa immediately relayed the information to the more than 100 people working under him. "I don't think these are rumors," he said. "The BOJ could be making preparations."

Matsuzawa and his team worked through the weekend hammering out scenarios, then held an emergency teleconference on Monday to discuss asset management strategy with roughly 200 Japanese investors.

Since then, the eyes of the world have been glued to the BOJ. When the markets opened that Monday, July 23, long-term yields jumped sharply.

After years of being motionless, Japan's interest rates have regained life. But ahead of a two-day policy meeting starting this coming Monday, the BOJ showed it was determined to quell rumors and regain control over rates.

On July 23 and 27, the central bank announced plans for unlimited fixed-rate bond buying. It was the first time the BOJ took such action twice in the same month.

Furthermore, Friday's operation set the yield for 10-year Japanese government bonds 1 basis point lower at 0.1%. The central bank appears to be attempting to reel in the 10-year yield, which touched 0.105% on Friday.

The BOJ aims "to tamp down on market speculation," said Kazuhiko Sano at Tokai Tokyo Securities.

But the genie is out of the bottle. On the morning of July 23, when bankers returned to work from the weekend after the news broke, a fixed-income manager at a regional bank in western Japan gathered staff and instructed them on how to face the situation.

"If interest rates climb, let's buy bonds," he said. As long-term yields rose that morning, the bank pounced on what it called a "perfect buying opportunity," and purchased tens of billions of yen (10 billion yen equals $90 million) worth of 10-year debt in one day.

Meanwhile, there were traders looking at the situation with inexperienced fear. "After so many years of continued low interest rates, many investors have no experience with climbing yields," said Naoto Oguri, president of Nagomi Capital, which provides asset management consultation to Japanese regional banks. "They feel dread in a minor rise in yields, and they become no longer able to trade calmly." Those fears were behind a certain amount of selling that emerged from those looking to limit their losses.

Long-term yields traditionally function as a prognosticator of economic and price trends, as well as a barometer of investor attitudes. But the BOJ has defied this logic by gaining control over market forces with its powerful tool kit.

Not all were happy with this state of affairs. "I wish the BOJ would loosen up somewhat on the reins and let the market become revitalized," one market insider said.

But if the central bank steps back, long-term yields will start moving again, and observers could misinterpret the move as monetary tapering -- a reduction of the quantitative easing policy -- which would impact the global market.

A similar script played out in 2013, when then-U.S. Federal Reserve Chairman Ben Bernanke appeared to hint at a drawdown of the quantitative easing policy, sparking a "taper tantrum" that caused a slide in emerging-market currencies and equities.

"The impact of a 'Kuroda tantrum' could reach a level that dwarfs" the U.S. taper tantrum, said Hiroaki Hayashi, managing director at Fukoku Capital Management. He cited the elements of BOJ policy that directly affect stock prices, such as the expansive purchases of exchange-traded funds.

If the BOJ adjusts interest rates, Japanese equities may be caught in a domino effect, Hayashi added. "It could trigger a sell-off by players such as foreign speculators and such," he said.

Learning from the taper tantrum, Fed officials have worked to avoid giving the market the wrong idea. Bernanke successor Janet Yellen, who initiated the tapering of the central bank's balance sheet, downplayed the process last year by saying it would be as exciting as "watching paint dry."

Kuroda, who built a reputation of surprising the market, said in April that he wished to avoid causing a great impact due to a misunderstanding.

"The monetary easing policy that suppresses long-term interest rates is realized by artificially constraining market functions," a senior BOJ official said. "It will be difficult to gradually adjust yields."

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