BOJ goes from stopping advance in yields to battle decline

Bloomberg

After spending a year trying to prevent benchmark yields from rising above zero percent, the Bank of Japan (BOJ) now faces the challenge of stopping them from falling too low.
Japan’s 10-year yield has gone from a one-year high in February to slipping below the BOJ’s targeted zero percent level earlier this month amid a bout of global risk aversion stemming from North Korea tensions. While the central bank has cut back on its debt purchases three times since mid-August, strategists question if that will be enough should global bonds keep rallying.
“I am worried about yields falling too low, which would be risky,” said Yusuke Ikawa, Japan strategist at BNP Paribas Securities Ltd. in Tokyo. “The more the BOJ owns bonds, the more downward pressure it puts on yields. The bank will likely continue gradually scaling back purchases, but it can’t reduce outstanding debt holdings under its monetary base expansion policy.”
Should yields stay negative for a sustained period, demand for Japanese bonds may slump, hurting an already moribund market.
While the strategy has enabled the BOJ to be more flexible with bond purchases, Kuroda has maintained that Japan still needs stimulus, with the central bank in July pushing back for the sixth time its timing for reaching the inflation target.
“The issue is when yields fall during times of global risk aversion,” said Koichi Sugisaki, a strategist with Morgan Stanley MUFG Securities Co. “If the BOJ cuts purchases to contain the drop in yields, it effectively means monetary tightening. It is a really scary scenario.”
Japanese financial markets suggested that any snap election called by Prime Minister Shinzo Abe was likely to see him retain power. That could mean the continuation of Abenomics — the recipe of ultra-loose monetary stance, flexible fiscal policy and selective deregulation — which according to Mizuho Securities Co. could likely cause the upward momentum on interest rates to dissipate.
Kuroda said late last month that despite some signs of reduced liquidity, the market for Japanese government bonds is “functioning quite well” and actually makes it easier for the BOJ to manage yields with fewer purchases. The 10-year yield briefly shot up to 0.15 percent in February, before the BOJ stepped in with its unlimited fixed-rate buying operations. It fell to -0.015% on September 8, the lowest since November.

BOJ Holdings
The BOJ holds about 40 percent of Japan’s outstanding government bonds. About 31 percent of all the securities held by the central bank as of end-August were in the five-to-10-year maturity segment, according to Bloomberg calculations based on BOJ data excluding floating-rate and inflation-indexed securities. About 25 percent of its holdings comprised debt due in less than two years and another 25 percent were in the two-to-five-year zone.
“Even for those looking to make a profit from the BOJ trade, returns from such a trade would wane if the BOJ keeps cutting purchases,” said Yasunobu
Katsuki, senior analyst at Mizuho Securities.