Government bonds are themselves becoming more illiquid, most particularly, as CLSA’s Chris Wood notes, in a country like Japan where the Bank of Japan has been buying more than the net issuance. Monthly trading of JGBs by lenders and insurers has collapsed from a peak of ¥123tn in April 2012 to a record low of ¥15tn in May 2016.
This raises the pertinent issue of whether the Bank of Japan has reached the practical limit of its government buying programme in terms of its current purchase programme of ¥80tn relative to estimated annual JGB net new issuance of ¥34tn.
In this respect, the Japanese central bank has from a potentially monetisation standpoint always defended the integrity of its JGB purchase programme by stressing that it only buys JGBs in the secondary market, which means that the seller of the JGB to the BoJ forfeits a claim to that asset. This is contrasted to what would happen if the BoJ bought JGBs in the primary market on an open-ended basis.
Such a process would be highly inflationary and, sooner or later, would be viewed by the market as such.
And as Wood concludes, the next step is obvious…
The above discussion on how future experiments with unconventional policy could impact markets is far from theoretical since all the evidence is that central bankers are not prepared to acknowledge the overwhelming empirical evidence that their policies are not working and, indeed, are having the opposite effect of what is intended. Instead they remain obsessed with policy frameworks influenced by inflation targeting and monitoring inflation expectations. It is, therefore, critical for investors to focus on what could be the next version of the monetary laboratory experiment with the obvious catalyst for that turning point market realisation that the Federal Reserve is not going to be able to normalise monetary policy.
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