Back in October 2014, just after the BOJ drastically expanded its QE operation, we warned that the biggest risk facing the BOJ (and the ECB, and the Fed, and all other central banks actively soaking up securities from the open market) was a lack of monetizable supply. We cited Takuji Okubo, chief economist at Japan Macro Advisors in Tokyo, who said that at the scale of its current debt monetization, the BOJ could end up owning half of the JGB market by as early as in 2018. He added that “The BOJ is basically declaring that Japan will need to fix its long-term problems by 2018, or risk becoming a failed nation.”
Which is why 17 months ago we predicted that, contrary to expectations of even more QE from Kuroda, we said “the BOJ will not boost QE, and if anything will have no choice but to start tapering it down – just like the Fed did when its interventions created the current illiquidity in the US govt market – especially since liquidity in the Japanese government market is now non-existent and getting worse by the day.”
As part of our conclusion, we said we do not “expect the media to grasp the profound implications of this analysis not only for the BOJ but for all other central banks: we expect this to be summer of 2016’s business.”
Since then, the forecast has panned out largely as expected: both the ECB and BOJ, finding themselves collateral constrained, were forced to expand into other, even more unconventional methods of easing, whether it be NIRP in the case of the BOJ, or the outright purchases of corporate bonds as the ECB did a month ago.
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Then, in September of 2015, the IMF realized the severity of what our forecast meant for Japan, and released a working paper with the non-pretentious title “Portfolio Rebalancing in Japan; Constraints and Implications for Quantitative Easing”, which however had momentous implications because it was a replica of what we had said a year earlier.
In the paper, the IMF said that the Bank of Japan may need to reduce the pace of its bond purchases in a few years due to a shortage of sellers. The paper predicted a world in which, just as we cautioned, “the BoJ may need to taper its JGB purchases in 2017 or 2018, given collateral needs of banks, asset-liability management constraints of insurers, and announced asset allocation targets of major pension funds… there is likely to be a “minimum” level of demand for JGBs from banks, pension funds, and insurance companies due to collateral needs, asset allocation targets, and asset-liability management (ALM) requirements. As such, the sustainability of the BoJ’s current pace of JGB purchases may become an issue.”
The paper’s shocking punchline was how Japan would survive this inevitable phase shift, or as we rhetorically asked, what happens when the regime shifts from the current buying phase to its inverse: The IMF response: “As this limit approaches and once the BoJ starts to exit, the market could move from a situation of shortage to one with excess supply. The term premium could jump depending on whether the BoJ shrinks its balance sheet and on the fiscal deficit over the medium term.
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