BOJ prepares for negative bond yields as it expands its QE

19th September 2012

"The Bank decided to increase the total size of the Program by about 10 trillion yen, from about 70 trillion yen to about 80 trillion yen. The increase in the size of the Program corresponds with the size of additional purchases of treasury discount bills (T-Bills) by about 5 trillion yen and Japanese government bonds (JGBs) by about 5 trillion yen."

So far so conventional as the Bank of Japan joins the Federal Reserve of the United States in singing Elvis Costello's "Pump It Up" this September. Those of you who look for nuance may spot something different in Japanese Quantitative Easing (QE) which is that short-dated Treasury Bills ( 3 months to one year) are purchased. The Bank of England refrains from buying even shorter-dated bonds and currently only buys maturities of around three years plus and the Federal Reserve is actively selling them so it can buy longer-dated bonds as part of Operation Twist! Ahem, intellectual consistency anyone?

The Bank of Japan is in effect announcing purchases for 2013 as it was already planning purchases for the rest of 2012 so we get a hint of what sort of economic activity it is expecting by its deeds as much as its words I think.

Also those who think of Japan as a precise technocratic nation may be mulling the regular use of the word "about" in the statement.

Negative Yields Alert

There was a development also today which the Bank of Japan has hinted at over the past few months. It feeds right into my negative yield theme. The section in normal type remains and the section in bold used to be there but has now been omitted:

"A multiple-price competitive auction shall be conducted for each purchase where counterparties bid "yield spreads," which shall not be negative and are calculated by subtracting the minimum yield of 0.1 percent per annum from the yield at which counterparties desire to sell JGBs (and now T-Bills) to the Bank."

So we see that the Bank of Japan is now willing to buy bonds down to virtually zero yield and looks as though it is preparing the ground in case it feels it has to buy them at a negative yield.

Why does this matter?

There is a theoretical issue which is that a bond is an instrument which pays a yield and thereby gets a value. What is a central bank saying about the value of a country's bonds and bills if it buys at a negative yield? Negative value? An interesting implication.

For Japan her government bond yields are at approximately 0.1% up to the four-year maturity so this is the area where the new rules are likely to first apply.

Why are they doing this?

I discussed the apparent slowdown in the Japanese economy back on the 27th of July and from today's statement it appears that the Bank of Japan agrees:

"Nonetheless, the pick-up in economic activity has come to a pause………..economic activity is expected to level off more or less and the year-on-year rate of change in the CPI to remain at around 0 percent for the time being"

Of course it is all the gaijin's fault! If you look at the Japanese word for foreigner you may choose to note that alien may be a better translation:

"Overseas economies have moved somewhat deeper into a deceleration phase."

Mind you, to be fair, there is an element of truth in it this time although it glosses over Japan's own economic problems.

Speaking of glossing over things

The Bank of Japan describes its actions thus:

"in pursuit of powerful monetary easing…….and pursuing powerful monetary easing"

An odd description you might think as something which is "powerful" might well have been expected to work at least a little bit over twenty years don't you think? Even if one is nice to them and just considers QE alone they have been trying that for a (lost) decade now. I think we can safely add "powerful" to my financial lexicon for these times.

The Value of the Yen: More Currency Wars?

This may have been a factor in the Bank of Japan's action. The exchange rate of the Yen versus the US Dollar has remained in the same region for quite a while. Whilst the focus of the mainstream media has left this issue it is the same level which we were told would make life very difficult for Japanese exporters. The dip into the low 77s versus the US dollar may have put pressure on the Bank of Japan even though the move had then reversed.

So to the extent that the beginning of QE3 in the US led to fears of US Dollar weakness this may well be a response to that. This will raise fears of the competitive devaluations of the 1920s and 30s although that is somewhat unfair on Japan who has suffered from a currency appreciation in recent times.

If we look at past history then some actual foreign exchange intervention by Japan has now got more likely.

More, More, More

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More on Mindful Money:

US equities: has the QE3 boost happened?

Financialist: US-China trade tensions grow

UK CPI continues to exceed average earnings growth

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