Stress in Japanese corporate bonds seen as a sign of things to come
Five year corporate bond yields have risen 10 basis points since mid-April as the 59.2 trillion yen (403 billion pounds) corporate bond market fretted that the BOJ could soon reduce its purchases of these securities.
That's a sizeable move in yields in an economy where short-term policy rates are negative and where the central bank massively buys up securities, including government bonds and equities, to keep rates near zero.
Most economists also reckon the BOJ is a long way off from exiting that policy, given it is nowhere close to achieving its 2 percent inflation target.
But the corporate bonds market is becoming uneasy, providing a worrying glimpse of what lies ahead for the mammoth government bonds sector when the time comes.
"It is getting difficult for brokers to sell the corporate bonds they buy in the primary market to the BOJ," said a director at a U.S. securities house.
"This could be the indirect impact of a reduction in the Bank of Japan's bond buying," he said, referring to the BOJ's purchases of Japanese government bonds (JGBs).
While Japan's central bank has for long held that any talk of an exit from its four-year-old quantitative easing policy is premature, there have been subtle changes this year.
The BOJ has, for example, gradually reduced the pace of its bond buying. In April, the BOJ bought 8.4 trillion yen of JGBs, compared to the average of 9.5 trillion yen last year.
Also unusually, two top BOJ officials last week discussed the issue of an exit from current policy for the first time since the stimulus plan was unveiled in 2013 with the singular aim of jump-starting Japan's moribund economy.
Governor Haruhiko Kuroda said the central bank will consider publishing calculations on how a future withdrawal of massive monetary stimulus could affect its financial health, while Executive Director Masayoshi Amamiya, seen as the architect of the stimulus, spoke of the range of tools the BOJ has to whittle down its gigantic balance sheet.
"The BOJ could be thinking ahead, given that they cannot continue the current pace of buying," said Makoto Sakuma, researcher at NLI Research Institute.
The corporate bond market has also been planning ahead.
Since March, traders have been trying to sell more of their corporate bonds to the BOJ, scrambling to offload stock that they bought at extremely low yields in the past believing they could quickly sell them to the BOJ at a profitable spread.
In March the BOJ's corporate bond buying operation attracted selling of 4.39 times the amount the central bank bought. That bid ratio was 4.75 times in April. Before March, the ratio had never exceeded three.
Simultaneously, yields on Japanese corporate bonds have risen, with the five-year bonds with single A rating now yielding 0.45 percent, up from around 0.35 percent in April.
JGB yields have been steady so far, thanks to the BOJ's pledge under its yield curve control policy to keep 10-year bond yields around zero percent. Its intervention in JGBs is also heavier.
Since late 2013, the BOJ has not expanded its corporate bond holding, keeping it steady at 3.2 trillion Japanese yen ($28.2 billion) and buying an amount that just replaces maturing bonds.
The BOJ bought 1.3 trillion yen worth of bonds last year, 12.3 percent of the year's total corporate bond issuance of 10.6 trillion yen, and 2.2 percent of the outstanding 59.2 trillion yen of corporate bonds on issue.
In contrast, the BOJ bought 114.4 trillion yen worth of JGBs in 2016, 71.7 percent of new issues and 12.7 percent of the total market size of 903 trillion yen.
"The credit spreads of Japanese corporate bonds are so tight. If the BOJ simply stops buying now, there won't be big problems," said Hidenori Suezawa, financial market analyst at SMBC Nikko Securities.
"But if the BOJ stops buying JGBs, who else will buy them?"
It has also been easier for speculators to take on the BOJ in the smaller corporate bond market, rather than in JGBs where it recently proved in February that it is committed to keeping 10-year yields around zero percent.
"The policy to guide the bond yield at a certain level would work for a certain period of time. But if markets start to think that the target is not in line with economic fundamentals, they will attack the target and that could drive up market volatility," said Sakuma of NLI Research Institute.
(Reporting by Hideyuki Sano and Yasunori Fukui; Editing by Vidya Ranganathan and Eric Meijer)
By Hideyuki Sano and Yasunori Fukui