May 18, 2017 6:15 am JST
BOJ watch

Has the Bank of Japan really tamed long rates?

Eerie quiet falls over government bond market, but storm may be coming

MISA HAMA, Nikkei staff writer

The Bank of Japan's headquarters in Tokyo

TOKYO -- The Bank of Japan has managed to stabilize long-term interest rates at its target level of around 0%, but its efforts have sapped vitality out of the Japanese government bond market and may have planted the seeds of future volatility.

Japan Bond Trading, which brokers buying and selling of bonds among dealers, did not handle any trades of newly issued 10-year JGBs on May 1. On Monday, the first transaction in the benchmark government debt security did not go through until the evening trading session.

JGB trades handled by the firm represent just a portion of the total flow, since many of the bonds change hands through direct deals between brokerages and investors. Nevertheless, "the market overall, including over-the-counter deals, has been shrinking bit by bit," said an employee of a brokerage who handles bond sales.

The main reason for the waning of the JGB market is voracious buying by the BOJ under its monetary easing policy. With the central bank having gobbled up so many JGBs, there are simply fewer of them to be traded on the market. New bonds are being issued, but those, too, are soon pounced on by the central bank.

"Since yields and prices don't move much, there is no reason now to actively trade JGBs," a bond dealer at a securities firm said. "Players are exiting the market." 

The BOJ does not appear to think there is a big problem in the market, however. It would be concerned if it could not sell or buy JGBs or if bid and ask prices diverged widely, but it does not see such conditions today.

In a way, the anemic bond market shows that the BOJ has succeeded in controlling interest rates. JGB yields do not move as much as before. This makes the bonds less attractive for investors looking to make quick profits out of price movements.

Central bank officials also believe that stability is what market players want. One factor muting interest rate fluctuations of late is the BOJ's publication of its bond purchasing schedule. This practice began in late February in response to market participants' criticism that the timing of the central bank's moves in the JGB market was unclear.

It is ironic that more transparency has led to less trading, but the dominant thinking at the BOJ is that beating deflation is more important than attending to market functions.

Many at the central bank believe that temporary market paralysis is an acceptable cost if it helps to put the Japanese economy on a firm path out of deflation. This means the bank likely will maintain in the foreseeable future policies that are conducive to sparking consumer price growth. This also means that liquidity in the JGB market likely will continue to dwindle.

If liquidity falls to an extreme level, however, it could create a risk of wild fluctuations in interest rates somewhere down the line. The current interest rate environment may just turn out to be the calm before the storm.

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