But into that panic a crazy thing happened. Worried its bonds would trade at negative yields and pressure the financial system, the Bank of Japan pegged its 10 year yield at 0%.
Pegged with money printed from nothing
by hitting 'Enter' on a keyboard at the Bank of Japan
In doing so, the Bank of Japan moved from a set rate of balance sheet expansion to one that varies based on whether that peg is either too high, or too low.
If the equilibrium level of 10 year rates was in fact below 0%, the Bank of Japan would be forced to sell bonds to keep rates stuck at 0%. If there was demand for credit and 10 year rates moved higher, then the BoJ would be forced to buy bonds to keep them from declining.
When the Boj buys bonds, it creates the money to do so,
enabling a process of the money in circulation becoming 'worth' less
...the BoJ was giving up control of its balance sheet so it could peg a specific part of the yield curve. Of course Central Banks do this all the time. The difference is they usually operate at the front part of the curve, and when there is too much demand or supply, they change the rate.
...by pegging the 10 year rate, the Bank of Japan had not eliminated volatility, but merely postponed it.
Eventually the Bank of Japan’s massive balance sheet expansion would kick in. At that point, inflation would pick up, credit would be demanded and the Bank of Japan would be forced to defend the 0% peg. Yet this defending would be expansionary as they would be forced to buy bonds and expand the amount of base money, which if not offset with a decline in the velocity of money, would create more inflation, etc… All of this would be occurring with an already highly supercharged Japanese Central Bank balance sheet.
...When 10 year rates drifted far enough above 0%, the Bank of Japan made a bid to buy an unlimited number of bonds at a level below the market, which scared the market back to the pegged level.
But last night the market decided to test the BoJ’s resolve.
The JGB 10 Year bond spiked through the previous high yield on news the Bank of Japan would not be expanding their balance sheet quite as aggressively as expected in their regular QE program.
As yields popped through the previous 0.10% yield ceiling, the Bank of Japan came charging into the market. The BoJ bid 3-4 basis points through the market with unlimited size to push yields back down to the 0.10% level.
What does this mean?
The market is finally saying the demand for credit is enough to force the Bank of Japan to buy bonds to keep rates down.
...we [may] have reached the point where ...The pressure will continue to build and when it finally bursts, the torrent will be overwhelming and quick...
Meaning interest rates spike higher,
leaving bond investors with massive losses
I hate German bunds, but I now have a fixed income instrument I hate even more. I expect bund yields to double or even triple in the coming quarters, but JGBs will eventually trade significantly though bunds.
It would be just like the Market Gods to finally usher in the JGBs collapse once all the hedge fund guys had given up on it…"