FOCUS - Japan bond auction failure due to mkt bubble, risks from BoJ moves
-- by Tony Barrett --
TOKYO (AFX-ASIA) - The failure of today's 10-year government bond auction was spurred by the Bank of Japan's plan to buy banks' shareholdings but should be seen within the context of the correction of a market bubble, analysts said.
Most were unconcerned over the shortfall in auction bids, though some said BoJ's plan, by placing the credibility of the bank and currency on the line, places the onus on the government to come up with meaningful reforms.
The auction failed to receive enough bids to take up all of the bonds offered by the Ministry of Finance, the ministry said, with bids totalling 1.185 trln yen, compared with the offer of 1.8 trln.
Central bank governor Masaru Hayami said he was unconcerned over the auction result, saying the weak response was simply a corrective reaction to the recent sharp decline in yields.
"With the shock announcement, the BoJ was throwing the ball to the government's court, telling it to come up with new policies," said Hidenori Suezawa, chief bond strategist at Daiwa SMBC.
"Market participants kept their hands off the auction because they wanted to see the government's economic package first," he said, though adding that the fundamental demand for bonds appeared to be relatively healthy.
Merrill Lynch fixed-income analyst Takuji Aida said the central bank is holding a "knife to the throat" of the government.
"My position is this is, of course, some kind of adjustment in a bubble of long-term yields but the fundamentals are also to do with the BoJ moves as such kind of monetary policy decreases confidence in the yen," Aida said.
"Of course, the government moves are more important because the BoJ has put a kind of knife to the throat of the government," he said.
"The government wants to avoid a long-term yield hike because of the cost of its fiscal deficit and the BoJ's move is a kind of threat for the government," he added.
Aida noted market disappointment over Prime Minister Junichiro Koizumi's comments yesterday that failed to suggest any new reform proposals.
"If the government increases disposals of bad loans, it will cause temporary deflation and it will ameliorate a rate hike but Koizumi's speech didn't say anything," Aida said.
"After the BoJ move, fiscal policy is much more difficult for the government to handle. To increase bad-debt disposals they have to create a bigger safety net. They have to spend more but it could drive up long-term yields," he said.
"There is this consistent premium on the long-term yield because the confidence in the yen is falling. I think the long-term yields will rise further," he said.
"If the government does not do anything, there will be some kind of crisis next year" as the current cyclical recovery wanes.
"The government should deal much faster with the bad debt disposal and create better fundamentals for the economy. I hope they do," Aida added.
However, others were less concerned.
"I don't think the failure to cover this auction is part of a trend towards auctions being uncovered. You would expect that in an economy at a point of collapse," said John Richards, fixed-income strategist at Barclays.
"It is extremely embarrassing for the second largest economy in the world not to be covering its auctions. What's embarrassing is the lack of policy reform," he said, referring to disappointment over government inertia.
"This is not about risk but uncertainty as we have no idea what's going to happen (on the policy front)," he said.
"What was supposed to be a routine (BoJ) policy meeting was a major change, which lost them (participants) 20 basis points. Everyone who bought bonds in the last six weeks was under water," he added.
The lack of clarity on whether the government will match the central bank's radical move with more sudden changes helped keep investors on the sidelines.
"The dealers were not stepping up. Banks are clearly shortening durations," Richards said, though adding that if the Finance Ministry had set a coupon of 1.3%, rather than 1.2%, the auction would have been relative smooth.
Mizuho Securities quantitative analyst Naoki Suzuki noted that funds have been shifting into the government bond market since the latter half of August, pushing down the yields.
"With the BoJ announcement, the market condition worsened. But I see the result of the auction as a part of the correctional trend in the past month," Suzuki added.
HSBC Securities senior economist Peter Morgan said he sees little risk of a financial crisis if the central bank includes a relatively small amount of equities on its balance sheet.
"I don't see any change in the fundamentals. Bond yields at 1% were looking a bit bubbly and there were unrealistic expectations that the BoJ would bail out people and issue new bonds," Morgan said.
"I think the BoJ will step up issues at some point," he said, though the earlier decision by the central bank to study buying shareholdings from domestic banks had encouraged investors to hope for a more dramatic move.
Morgan said he sees little worry that the BoJ has undermined its credibility and the issue of government bonds through its proposal.
The shares that would be bought are "a very small amount. They have reserves. They can swallow it pretty easily," he said.
However, Barclays' Richards said 10-year government bond yields may continue to rise mildly.
"Risks are that the yields will go higher. The centre of gravity is around 1.30-1.35% for 10 years," he said, based on the BoJ's moves so far.
Massive additional policy shifts by the Finance Ministry or government, such as a policy of weakening the exchange rate could push yields back to 1.40%, Richards added. "If several other shoes drop, they will back up a bit."
© AFX News
Also, separate article
Japan may see crisis next yr as BoJ has 'knife to throat' of govt - Merrill
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