Japan sinks into recession – but there is more to the story than the mainstream narrative would care to admit
Last week (February 15, 2024), the Japanese Cabinet Office released the latest national accounts estimates…
The hysteria surrounding the decision by the Bank of Japan (released December 19, 2022) to make a minor adjustment to its yield curve control ceiling on Japanese government 10-year bonds has been predictable but uninformed and full of vested interest agendas. You know the type of agenda that investment bankers engage in where they consistently pump out their media statements, which are soaked up by the financial media as if they are knowledge that needs repeating, that claim interest rates have to rise to deal with some inflation emergency or something. The media doesn’t tell the public who absorb this stuff that the actual agenda is that bankers want higher interest rates because they make more profit and that the reason the media statements give is largely fiction. So we are seeing more of that in the last few days. My understanding of the decision is that it does not signal a fundamental change in monetary policy in Japan. It is a minor shift to tweak the interface between the government bond market and the corporate bond market in order to maintain financial stability – the most important role of a central bank. All those characters that are claiming the hedge funds have won and the Bank of Japan is now conceding power to them with interest rate hikes to come are not reading the room. They are just pushing their self-interest in vain. No interest rates went up and my reading of the statement and what I know informally via contacts is that the Bank is committed to its current policy position because it considers, as I do, the inflationary pressures to be transitory and doesn’t want to respond to an ephemeral problem by creating a more entrenched problem of real economy recession and rising unemployment.
The Internet generate these headlines in my news feed this morning.
The framing, the words, all point to some calamity that is about to manifest.
All unnecessary in fact.
On December 20, 2022, the Bank of Japan released this statement – Statement on Monetary Policy – which announced that:
… the Bank of Japan decided to modify the conduct of yield curve control in order to improve market functioning and encourage a smoother formation of the entire yield curve, while maintaining accommodative financial conditions.
The last phrase tells us about the direction of monetary policy – “maintaining accommodative financial conditions”.
The Bank decided to:
1. “The Bank will apply a negative interest rate of minus 0.1 percent to the Policy-Rate Balances in current accounts held by financial institutions at the Bank” – this is the principle statement.
No change in interest rates announced.
2. “The Bank will purchase a necessary amount of JGBs without setting an upper limit so that 10-year JGB yields will remain at around zero percent” – no limit to the on-going purchases of JGBs in the secondary bond market to keep 10-year bond yields around zero.
In other words, no change in its bond buying program other than to increase the monthly bond purchases by about 20 per cent.
It is prepared to use its infinite financial capacity as the issuer of yen to buy up as many bonds as is necessary to maintain their target range on bond yields.
3. The third part of the announcement signalled a slight variation on existing policy:
While significantly increasing the amount of JGB purchases … the Bank will expand the range of 10-year JGB yield fluctuations from the target level: from between around plus and minus 0.25 percentage points to between around plus and minus 0.5 percentage points.
The Bank will offer to purchase 10-year JGBs at 0.5 percent every business day through fixed-rate purchase operations, unless it is highly likely that no bids will be submitted. In order to encourage the formation of a yield curve that is consistent with the above guideline for market operations, the Bank will make nimble responses for each maturity by increasing the amount of JGB purchases even more and conducting fixed- rate purchase operations.
So that is the change.
The ceiling for 10-year JGB that the Bank is controlling will rise from 0.25 percentage points to 0.5 percentage points, which is the new yield that the Bank will make offers at.
Remember the yield and the price of a government bond vary inversely and by making bids on price the Bank can control the resulting yield.
A central bank can always do this whenever it wants and can hold the yield at whatever target they like irrespective of what the bond market investors might think is best for them.
The Bank also stated it would continue to purchase non-government financial assets (for example, Exchange-traded funds, real estate trusts) and corporate bonds at rates that prevailed prior to the pandemic.
The response in the financial press was overblown to say the least.
The Economist magazine claimed it “may herald a period of tightening” despite the Bank’s statement explicitly stating otherwise.
The Economist claimed that after the announcement the 10-year bond yield had “surged” – it rose modestly from 0.25 to 0.4 per cent in line with the changed policy.
It also claimed that the policy shift “spares the boj months of bond-buying to enforce the old cap, and the greater losses it would endure on its bigger bond portfolio.”
The Bank officials couldn’t care less about any ‘book’ losses that appear on its balance sheet as a result of interest rate changes affecting the sale price of the bonds they have previously bought.
All this talk around the globe at present about central banks taking losses totally misses the point that they are not commercial banks and can carry on with negative capital forever.
One investor quoted by the Economist claimed this was the beginning of “Operation Freedom”, which is code for the investors taking control again and reaping profits at the expense of the Japanese people.
The Bank is not about to allow that to happen even if it is the hope of the money markets.
There is a multitude of financial assets – government and non-government – which are traded on a daily basis.
They range in maturity from very short-term to very long-term, with the 10-year bond towards the longer end of the available maturity range.
Together the government bonds assets are referred to as the ‘yield curve’, which essentially is just a plot of the current yields from very short-term out to the longer maturity ranges.
Along the curve, yields of non-government financial assets, such as corporate bonds and the J-REITs, are influenced by what is happening in the government bond market.
That, after all, is the principle aim of quantitative easing – to influence the government bond yields at a particular maturity and then allow the ‘market’ to shift the yields of other non-government financial assets into line with the controlled government bond yields.
By increasing demand in the secondary bond market for a specific government bond maturity, the central bank forces up the traded price of that asset and drives the yield down.
It can control the yield at whatever level it chooses by varying the scale of its purchases.
And in doing so, it forces the yields of other non-government bonds etc down, which is the aim.
The central bank hopes that the lower rates at the ‘investment’ end of the yield curve – that is, the longer-term rates, will stimulate borrowing for capital formation in productive capacity (that is, investment), which will serve to stimulate the economy.
QE is not about ‘giving’ the banks etc more cash or liquidity.
It is about driving down long-term interest rates in the hope it will stimulate private investment spending on productive capacity.
The problem with it is that when an economy is languishing no-one wants to borrow anyway, even if borrowing rates fall significantly.
Getting back to the story here though – the Bank of Japan noted in its monetary policy statement that it was concerned that business firms may be finding its ability to fund themselves through corporate debt issuance more difficult.
It also noted that in recent months it has observed increased “volatility in overseas financial and capital markets … [which] … has significantly affected these markets in Japan”.
The functioning of bond markets has deteriorated, particularly in terms of relative relationships among interest rates of bonds with different maturities and arbitrage relationships between spot and futures markets. Yields on Japanese government bonds (JGBs) are reference rates for corporate bond yields, bank lending rates, and other funding rates. If these market conditions persist, this could have a negative impact on financial conditions such as issuance conditions for corporate bonds.
This is the nub for understanding the change.
Over time, trading in some government bonds at different maturities has been very low and this has also affected the capacity of Japanese firms to issue corporate bonds at reasonable rates.
By allowing the 10-year JGB rate to reach a new, slightly higher ceiling, the Bank is hoping that the relationships along the yield curve will improve and Japanese firms will find more favourable conditions in which to launch their own bond issues.
That is really all there is to it.
The Bank was not responding to any increased inflation threat – it still thinks the current episode is transitory and will dissipate soon enough.
This was just a technical adjustment designed to improve the buying and selling conditions within the bond markets.
Meanwhile, the Japanese government is about to implement is fuel and utilities subsidy scheme in January, a fiscal policy move that will significantly reduce the cost-of-living pressures on Japanese households.
A different country for sure.
Everyone should have just read the last paragraph where the Bank notes:
For the time being, while closely monitoring the impact of COVID-19, the Bank will support financing, mainly of firms, and maintain stability in financial markets, and will not hesitate to take additional easing measures if necessary; it also expects short- and long-term policy interest rates to remain at their present or lower levels.
That tells you that the Bank is not in a panic and about to pull the ‘Operation Freedom’ trigger, despite the hopes of the greedy private market players.
Back to calm.
That is enough for today!
(c) Copyright 2022 William Mitchell. All Rights Reserved.