BoJ’s NIRP Boomerang: Nikkei 225 Pummeled 3.05% to Return to February Lows as JGB yields Hit Record Low! Goodbye Japan’s Financial Markets, Hello Socialism!

Japanese stocks tumbled 3.05% today. Media blamed this on the Bank of Japan’s inaction.

From Bloomberg

Stocks in Tokyo slumped, with the benchmark equity gauge closing at its lowest level in four months, as the yen surged after the Bank of Japan disappointed investors by refraining from adding to stimulus

The Topix index lost 2.8 percent to 1,241.56 at the close in Tokyo, the lowest since Feb. 12, after the yen touched its highest level since August 2014. All 33 groups on the equity gauge declined. The BOJ held its key interest rate at minus 0.1 percent and kept the annual target for expanding the monetary base at 80 trillion yen ($764 billion). About 28 percent of economists in a Bloomberg survey had forecast additional easing at this meeting.

Japanese stocks in bear markets again…

The Topix is down almost 20 percent this year, the steepest decline among developed markets behind Italy, as economic reports have deteriorated, stimulus from the BOJ has backfired and the yen’s surge has pressured exporters.

Let me add that as of today the Nikkei has been down 26% from its June 24, 2015 high of 20,868.03

“Disappointed investors” from the Bank of Japan’s “refraining from adding to stimulus” signifies a counterfactual. We will not know because it didn’t happen. While in the past this was consistently true, the past may not be the same as today.

The Nikkei was down close to 4% (3.98% to be exact) during the previous three days (excluding today). The Nikkei hasn't been showing signs of expecting a rescue.

And worst, including today’s carnage, the main Japanese bellwether has been down 13.61% from the highs that had been brought about by the Bank of Japan’s surprise Negative Interest Rate Policy (NIRP) announcement.

In other words, the BoJ’s actions seem as increasingly being discounted by Japan’s stock markets. 

Even more, with today’s breakdown from the April lows, the Nikkei have just been off by 3.11% from the February lows!

So from this perspective, the past may not be the future.

Yet so much for the BoJ’s wish for the rejuvenation of the 'animal spirits' of the average Japanese investor. It has not and will not be happening. There is no magic in inflationism!

And from this perspective, the credibility of the BoJ seems increasingly on the spot

Of course, it is sad to see how markets have become all so deformed. That’s because parts of the establishment continues to still HOPE for BoJ interventions just to prop up the markets.

Yet the more important development of the day has been the new record set by Japanese Government Bonds (JGB).

From today’s Nikkei Asia

The yield on the benchmark 10-year government bonds fell to a record low of minus 0.210%, down 0.015 percentage point from the previous day. Demand for Japanese government bonds, considered a safe-haven asset, picked up as concerns continued to grow that Britain may vote to leave the European Union in a referendum next week.

The yield on 20-year JGBs fell 0.020 percentage point on the day to a record low of 0.120%, while the yield on 30-year JGBs slid 0.020 percentage point to 0.190%, also a record low.

As I have been saying here, JGBs are one of the world’s real time ticking financial nuclear time bombs.

And those record high bond prices have not been about demand and supply but about how the JGBs have morphed into a Frankenstein market.

Reason? There is only a single buyer in the market: the BoJ! And because the BoJ has been the only buyer, liquidity has evaporated!

From today’s Nikkei Asia. (bold mine)

But higher JGB prices, which are pushing yields to historic lows, are not an indication of increased market demand. The average daily trading of newly issued 10-year JGBs has narrowed from just over 100 billion yen ($943 million) in April to about 70 billion yen in June. Just 58.5 billion yen changed hands on Monday.

"Almost no domestic investors are selling," a JGB trader said.

Banks have been the main sellers of government debt since the Bank of Japan launched quantitative and qualitative easing measures in 2013. But their JGB holdings, including Japan Post Bank's, had dropped by a third to 237 trillion yen in the three years through 2015, according to the BOJ. The trend is especially striking among major institutions.

"Considering the collateral needed for financial trading, banks have basically hit bottom on JGBs," an asset manager said.

Insurance companies are also loath to part with government debt. "There's no draw in terms of the yield, but we can't cut down on JGB holdings," a source at a life insurer said. Many are reluctant to make the shift to foreign bonds, given high exchange rate risks and declining yields abroad. Pension funds face a similar conundrum as well.

Yet the BOJ continues to buy 80 trillion yen of JGBs a year as part of its stimulus package. The central bank and foreign investors together held over 40% of Japanese government debt at the end of 2015, and that is expected to near 50% by the end of this year.

"The market has hollowed out," a JGB trader said. "There's little breadth in trading, so yields will drop even if there's no reason to. And if yields start rising, they could shoot up out of control."

It has been curiosity or fascination to see how mainstream media have spoken audaciously against the BOJ.

Recently or just a week ago, the Nikkei Asia reported that the BoJ have been falling short of their JGB (asset) buying program

But the fact that the central bank has reduced its bond purchases below the target level for the fourth consecutive month indicates that maintaining the required pace of buying is becoming increasingly difficult.

So the managing of the balance sheets by Japan’s financial institutions have become an intensely arduous task because of the BoJ’s policies.

In fact, the BoJ has been pushing them to take on bigger risks. Some banks have complied. Some have elected to lend to lower grade borrowers via subordinated debt just to justify or chase on higher yields.

In short, the BoJ has been pushing its financial institutions to gamble away with their depositor’s resources!

Yet many banks have become undaunted with their opposition to the BoJ’s policies. (this explains media’s adversarial position)

From another Nikkei Asia article (bold mine)

Bank of Tokyo-Mitsubishi UFJ's decision to drop out as a primary dealer of Japanese government bonds reflects growing frustration among private-sector institutions hit hard by negative interest rates….

Banks had until recently accepted the BOJ's monetary easing policies, but their opposition to the negative rates has been unequivocal. Banks worry that without their protest, the central bank would continue plunging deeper into negative territory.

But that's not the only reason for their frustration. A closer look at regional banks in Japan's northeastern Tohoku region reveal another possible factor for their discontent. Many of them see the negative rates as an unjust penalty on their deposits, which have grown from the inflow of reconstruction funds for the 2011 earthquake and tsunami.

Financial institutions used to be able to park their cash, either in current account deposits at the BOJ or as JGB holdings. But negative interests mean there are now actual costs to keeping money idle. Without the option of inaction, banks are now scrambling to pour their funds into investments and loans.

As I have said here systemic losses have been mounting.

As a side note, today, it’s not just Japan, but Australian and South Korean yields have fallen to record lows. As today’s Bloomberg report shows: The bond rally is sending benchmark 10-year yields to unprecedented levels in some countries. Japan’s tumbled to minus 0.21 percent. Australia’s fell below 2 percent. Germany’s plunged below zero. Switzerland’s longest-dated benchmark security -- the 30-year security -- offers the nation’s only positive yield at 0.027 percent. Negative yields, once considered unthinkable, are becoming more common.

And this significantly explains why Japan’s market has been selling off.

The BoJ has been crucifying its own banks and financial institutions! It has been trying to extract money from them through negative rates policies! It has been impelling the banks to move out into the risk curve to speculate and undertake big risks!

And so the Topix Bank ETF has been down 4.64% for the week and 33% year!

And here is what I believe is the kicker: the deepening socialism prospects of Japan’s financial markets through QE and NIRP will now be reinforced through fiscal policies or via taxation.

Remember, socialism mainly signifies as the public ownership of the means of production.

From the same article

The finance ministry has also considered taxing companies' internal reserves in order to encourage investments and larger dividends. The plan, which has yet to become reality, follows a similar logic to that of the BOJ -- influence corporate actions through imposing a de facto fine. Perhaps banks are reacting so strongly against negative interest rates because they see the policy as a form of government activism trying to force them to act in a certain way.

As the BoJ owns more share of Japan’s stock markets, intervention will not only get implemented through policies but will be imposed through the boardroom.

In other words, the Japanese government has used two ways to intervene, through policies and through the boardroom. Goodbye markets, hello socialism!

Oh by the way, another Nikkei Asia recently reported that Japan’s corporations posted record cash holding 109 trillion yen (US $1 trillion) at the close of the fiscal year 2015.

With the proportion of companies whose cash holdings exceeded interest-bearing debt increased 0.5 percentage point to 56.1%, these turned Japanese firms into free of debt, notes the article.

Holding cash is a manifestation of action and of opportunity costs. This simply means Japanese firms now prioritize conserving resources than investing them or than consuming them through distribution to shareholders through dividends or other means.

Why invest when property rights, which impacts investment returns, have been constantly assailed by the politicians? (regime uncertainty)

And also with banks under pressure from their chief regulator, hasn’t been a wonder why these firms will rather own cash?

From the investment aspect. Eventually such politicization will have to end, either the BoJ would stop or the markets will force them to stop. And given the huge cash position of Japan’s corporations, they would look very much like a wonderful buying opportunity—somewhere down the road.