A chart of Japanese government bonds is not on most traders main screen, but it should be.
The Bank of Japan is desperately trying to monetize their balance sheet aggressively enough to keep the Yen down and stop inflation from slipping back into deflation. They have long passed the “bat shit crazy” level of quantitative easing and have firmly entered the “are you shitting me?” stage. The Bank of Japan is buying so many JGBs, they are running out of supply.
When the BoJ recently added even more fuel to the fire with their move to negative rates, the whole Japanese yield curve slipped under 0% out to 10 years. Stuck with the bulk of their government bonds yielding less than zero, the BoJ must have ventured out the curve to concentrate their buying in maturities that still offered some positive yield.
This move has produced a violent reaction in their bond market. Take a look at the trading for the current 30 year JGB over the past month:
Two days ago it rallied 8 handles in one session! For a government bond, this was an absolutely insane move. Especially when you consider it was not driven by some fundamental change, but was instead the result of Central Bank flows.
And then just as quickly as it came, it sold off. Yesterday the JGB 30 year bond gave back 7 of the 8 big figures.
This is absolutely nut bar volatility. The JGB market has become an absolute joke dominated by the BoJ. They have pinned all the way out to 10 years to zero, and are about to do the same for 30 and 40 year paper:
In doing so, they have collapsed the yield curve. The 2/30 year yield spread has pushed to new lows.
What is most amazing about this chart is that the 2 year is yielding negative 23 basis points! Even with the extreme accommodation at the front end, the long end is flattening like deflation is inevitable.
Many of you will probably shrug and say “who cares?” But don’t be so quick to dismiss the JGBs.
There is no doubt the Bank of Japan is affecting world bond markets with their crazy policies. Have a look at the chart of the trading in the US long bond future over the past three days:
It was jerked up with the JGB move, and has now fallen right back down along side. The Bank of Japan is creating volatility throughout the globe.
But more important than the day to day squiggles is the potential for the Bank of Japan to lose control. At some point these crazy moves will cause something really big to break. There is no way any rational investor can look at the trading in the JGB market and not be scared. These sorts of moves are not the sort of stuff you see in properly functioning economies.
As for the other Central Banks…
I wanted to make a quick note about the upcoming Bank of Canada, ECB and Federal Reserve policy meetings. There is too much hope built into the price for the BoC and ECB decision, and not enough fear for the Federal Reserve.
This is an uncertain time, there can be no denying that. Central Bankers are perplexed how to restart the inflationary engine. But over the past three weeks, there have been some positive signs. Commodities have stopped going down. Financial conditions have loosened. Equities are rallying.
In the absence of a real crisis, it will be far easier for Central Bankers to take a wait and see approach than to continue aggressively easing. I don’t see the Bank of Canada doing any more than being cautiously optimistic. And as for the ECB, there is some real concern that further moves into even more negative territory will have little positive impact. There is a lot of overly optimistic speculation built into the ECB’s coming meeting. I suspect they will disappoint, but that might not be a bad thing. It might cause a Euro rally and an easing of the concerns about negative margins for the banks.
However, although I think the BoC and ECB will err on doing less than the market expects, the market is overly confident the Federal Reserve will not tighten at next week’s FOMC meeting. I don’t think it is likely, but it is more probable than current expectations suggest.
Markets think the Central Banks will somehow save them. Nothing could be further from the truth. In the short run they have built way too much hope into the coming meetings. And in the long run, markets don’t understand how close the Central Banks are to losing control.
Thanks for reading,