While we doubt anyone will laugh, we find it amusing that none other than arguably the “last holdout” of ZIRP and then NIRP, BOJ governor Haruhiko Kuroda, finally joined the chorus of people warning that low interest rates will “sow the seeds of the next financial crisis.” Echoing concerns voiced by Deutsche Bank and virtually every other bank over the past year, Kuroda said that “a new challenge has emerged in the form of low profitability at financial institutions,” adding that rapid growth in shadow banking and new financial technology were bringing big changes to the global banking environment.
“These developments suggest that a different kind of financial crisis could happen in the future,” he told an international conference on deposit insurers on Thursday, without elaborating. As Reuters writes overnight, “the remarks contrast with Kuroda’s previous comments emphasizing that the benefits of massive stimulus on the economy make up for potential negatives such as the hit to banks.”
Hoping to spread the blame, Kuroda said the problem of low interest rates hurting bank profitability was a global one, pointing to bad loans piling up at some European banks and headwinds plaguing Japanese banks from sluggish lending driven by an aging population. “For the financial system to ensure future stability, it is becoming more and more important in the long term to think about possible responses to low profitability at financial institutions,” he said.
In other words, Kuroda must have gotten an earful in his last meeting with bank execs.
And yet, we said this statement is amusing? Why? Because one look at the BOJ’s balance sheet explains precisely why Japan is currently grappling with trillions in negative yielding bonds.
That, and of course the BOJ’s impulsive decision, taken as a result of “peer pressure” suffered during last year’s Davos meeting, to unleash negative rates in Japan for the first time in history.
And now that it is no longer “fake news” to criticize central banks’ failing policies, Reuters takes Kuroda to task:
Four years of aggressive money printing by the BOJ have failed to pull Japan sustainably out of stagnation, forcing the central bank to revamp its policy framework to one better suited for a long-term battle with deflation.
But the attempts to revive Japan’s anemic consumer spending through unconventional monetary policy have created new problems for the central bank in its dealings with markets and financial institutions.
It’s not just Reuters who unloaded on the cartoonish central banker.
In a separate report looking at the confusion sowed by the BOJ’s decision to launch “Yield Curve Control” or YCC last September, Reuters also reports that “the sometimes contradictory market operations directives are sowing confusion over the BOJ’s intentions, creating tensions between the central bank and the market and underscoring the challenges of its unprecedented policy.”
“What’s clear is that market players don’t hold trust in the BOJ,” said Mari Iwashita, chief market economist at SMBC Friend Securities. “If there was trust, things wouldn’t be this messy.”
It sounds like a rising tide of mutinous discontent is rising against the BOJ’s monetary policy by Japan’s bond market, some of it even internally sourced: “It’s true, controlling long-term rates is an unprecedented policy,” BOJ Deputy Governor Hiroshi Nakaso told reporters last week, acknowledging that the bank was still learning how best to communicate its intentions to markets. However, he believes the BOJ has the necessary “skill and tools” to control yields.
Market players aren’t convinced, complaining about the lack of clarity on how the BOJ wants to guide long-term rates. “So many things are unclear, such as at what level the BOJ will step in to curb yield rises,” said a money market trader in Tokyo. A domestic bond market investor said “a lot of market players got burnt” from the volatility caused by the BOJ, which could discourage investors and dealers from trading actively.
The BOJ has put the job of controlling yields in the hands of a small group of relatively junior bureaucrats, who have no say on monetary policy but execute the board’s orders through daily transactions in the interest rate markets. Their actions have resulted in some substantial intraday swings in both the Yen and JGB yields, as reported recently. Under the YCC framework, the BOJ seeks to control the yield curve by targeting short-term rates at minus 0.1 percent and the 10-year yield around zero. The task of capping long-term rates, a feat never tested by a major central bank, is entrusted to a team of around 40 staff running the BOJ’s market operations.
As Reuters adds, a “handful of junior-ranking bureaucrats in the team, mostly in their 40s, decides when, how and to what degree the BOJ offers to buy bonds. Guidance from the board is vague and kept at a minimum to allow the team to respond flexibly to daily market moves.”
However, market participants say this ambiguity causes confusion as the bureaucrats, mandated to meet the board’s orders, do not focus much on the impact of their moves on the broader economy. The BOJ’s task is also made difficult by the conflicting goals embedded in the new framework. While targeting rates, the BOJ maintains a loose pledge to buy bonds at a set pace to appease advocates of aggressive asset purchases in the board.
The BOJ has caught markets off-guard several times. Yields spiked when it skipped a much-anticipated auction in January, stoking fears it may soon taper asset purchases. It then offered to buy unlimited amounts of bonds on Feb. 3, when the 10-year yield spiked to 0.15 percent.
BOJ officials say they have no plan to offer more specific guidance on their market operations, and stress their dominance in the market gives them enough power to suppress yields.
“Communication is important. But that doesn’t mean the BOJ should meet each and every request from the market,” said a source familiar with the central bank’s thinking.
And where this whole narrative comes together is that on one hand Kuroda suddenly wants higher rates, on the other he has some 40 junior bureaucrats in charge of making sure it does not happen, thanks to YCC. Adding pressure on Kuroda is that he suddenly finds himself alone in a world in which all other central banks have launched curve steepening experiments – whose outcome remains unclear – and as a result analysts doubt whether the BOJ could keep battling market forces if global yields continue to rise, particularly with its massive bond purchases seen as unsustainable.
Brightening prospects for Japan’s economy, usually good news for policymakers, could also heighten the BOJ’s challenges in capping bond yields. Japan’s economy expanded for four straight quarters in 2016 thanks to a rebound in global demand while analysts expect inflation to accelerate to near 1 percent later this year, which could push up Japanese yields.
Former BOJ central banker, Sayuri Shirai, who served on the BOJ’s board from 2011 to 2016, said the central bank’s YCC policy in its current form is confusing and causes big market distortions. “To make the framework more sustainable, it’s better to raise the yield target and gradually reduce bond purchases,” Shirai told Reuters in an interview on Wednesday.
That however will not happen. What however will happen is that Kuroda will be right: a financial crisis is likely headed for Japan, however not for the reason he believes; instead it will manifest itself once the market, which is already rising in mutiny against the BOJ’s policies, hits a tipping point, and the selling in the country with the 250% debt/GDP, and where the central bank owns 40% of all outstanding debt, begins.
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