Kuroda Leaves Wild Distorted Bond Market for Next BOJ Governor: In Charts

The Bank of Japan Governor Haruhiko Kuroda is in the twilight of his 10-year tenure. His successor inherits a bond market that is larger than ever, but riddled with wild distortions. The lingering question for Japan is how the central bank can normalize policy.

(Bloomberg) — The Bank of Japan Governor Haruhiko Kuroda is in the twilight of his 10-year tenure. His successor inherits a bond market that is larger than ever, but riddled with wild distortions. The lingering question for Japan is how the central bank can normalize policy.

The BOJ’s balance sheet was once about the same size relative to the economy as for the Federal Reserve and the European Central Bank. Now, its assets are worth substantially more than 100% of Japan’s gross domestic product.

Japan’s more than 1,000 trillion yen ($7.6 trillion) of bonds represent the largest developed debt market in the world outside of US Treasuries. The BOJ’s holdings of long-term government securities (excluding T-bills) soared to 535.6 trillion yen at the end of the third quarter, making up almost 80% of its assets at that time.

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That also leaves the central bank owning more than half of the bond market. Foreigners boosted theirs as the BOJ’s negative rates make the yen cheap, driving the Japanese to pay a premium to get their hands on US dollars.

The end result is that trading conditions are a mess, especially for the 10-year notes targeted under curve control. The BOJ now officially holds more than 100% of the last three benchmark 10-year bonds, creating stark gaps between those securities’ yields. At the same time, swap rates soared to underscore market expectations that yield caps will soon end.

Wild Yield Gaps Another Sign of Bond Distortion BOJ Causing

The yield curve itself — the rates across a range of maturities for Japanese government debt — is striving to spring back toward something more like its pre-Kuroda levels. For now, the BOJ’s policies are creating a most-unusual kink where 10-year yields hold below those from the seven- to nine-year area.

The curve is also notably at odds with those in the US and Germany, two of the traditional lodestones for global rates markets. Looking at the gap between five- and 30-year yields (to escape the tightly controlled 10-year space), the JGB curve was calmer, and often flatter for most of the period. Now, as Kuroda’s decade in charge winds down, it is steepening sharply while US and German gauges invert.

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