By Tyler Durden
On Friday, when we summarized why “It May Be Over For The BOJ” we presented a variety of sellside opinions, all of which were unanimously pessimistic on the BOJ’s latest policy, we observed that the weakest link for the BOJ’s latest incernation of QE, aka QQE with Yield Curve Control, or QQEWYCC (which even rhymes) would be if the 10Y JGB resumed its drift lower into negative territory, coupled with a return to curve flattening, two adverse side effects of its own prior policy which the BOJ is now explicitly trying to undo due to their adverse impact on the local banking and pension sectors.
However, as we noted overnight, in a very ominous development, or what already dubbed the BOJ’s “nightmare scenario” – for both the credibility of the BOJ and the return of VaR shocks first in Japan and soon elsewhere – the 10Y JGB did indeed resume sliding into deeper negative territory, away from Kuroda’s 0% price target, resulting immediately an a resumption in curve flattenting.
As RBC’s Charlie McElligott confirms, upon upon the reopening post-holiday late last week, “we saw the JGB curve ominously FLATTENING, despite the BoJ’s desired steepening message from its Wednesday meeting. More flattening has again occurred to start the week, and as you can see below, JGB 2s10s / 5s30s / 2s30s have all sharply reversed their prior steepening course on what looks to be tactical profit-taking through the BoJ meeting results.”
The developing narrative / question is how does the BoJ “control the message” that an attempt at steepening the curve is NOT interpreted by markets as a tapering of QE? The further complication is the new 10Y JGB yield ‘targeting’ policy as well, where theoretically you would see the BoJ conducting outright “tightening operations” in the case where yields were turning sharply negative again—because then the BoJ would then turn a SELLER of JGBs to drive yields back to their zero percent target.”
In other words, with the 10Y now yielding well below the BOJ’s own “fair value” target, the BOJ may have no choice but to telegraph it will buy less in this maturity bucket, leading not only to a further skewing of the JGB yield curve but an implicit tightening, or “tapering” of purchases, which may send not just the long end, but the short end also sharply higher, potentially flattening the yield curve even more!
Or, as McElligott elegantly puts it, “tangled web indeed, and as such, we see $yen probing back towards the 100 level (FWIW, RBC’s Todd Cross informs us this morning that MOF “legend” Sakakibara (“Mr. Yen himself) is now on the record as anticipating a Y90 by next year…if that were the case, I’d expect that next BoJ rate cut to even deeper NIRP at the very least, and further discussions on even more unconventional policy i.e. foreign bond purchases).”
And this is why the BOJ is now trapped and may have no way out from the nightmare scenario it itself has unleashed:
The problem is, the BoJ is currently back in “buying time” mode and needs at least a few months to watch their policies “play out”…it’s unlikely they could make further tweaks before Dec earliest, but most likely next calendar year. As such, my colleague Mark Orsley is pushing a trade in Nov Yen future upside via 102/104 calls (JYX6C) for spread of 0.40 in the case that the market turns vigilante and accelerates the Yen buying (USDJPY downside).
RBC’s conclusion: “JGB CURVES FLATTENING POST BoJ: Not part of the plan.”
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But worst of all for the Bank of Japan is that even Goldman Sachs, which arguably has the answer for everything, admitted last week that it has no idea how the central bank will control both the yield on the 10Y and the overall shape of the curve:
“it is very unclear at this time exactly how the BOJ intends to “control” the yield curve in the future. Based only on the official statement, we think it is likely it will maintain the yield curve at more or less the current level for the time being. However, the question is how it will control the overall level and shape of the curve when financial and economic conditions change in the future. While the JGB market needs to take time to study the BOJ’s intentions, with interest rate movements lessening, we think the pricing function of interest rates as a mirror reflecting real economic and financial conditions will be increasingly lost.”
Good luck Peter Pan, you will need it.