BoJ’s Nakaso: ‘No serious problems’ with JGB liquidity

New data shows a drop in market depth, but QE is not threatened, says deputy governor

Hiroshi Nakaso: Liquidity in JGBs is sound

The Bank of Japan's (BoJ) bond-buying programme has hurt the market's depth and resilience, but is unlikely to derail ongoing large-scale purchases, according to BoJ deputy governor, Hiroshi Nakaso. Further deterioration in the market could prompt the central bank to bolster liquidity through changes to market practice and market infrastructure, he said.

The conclusions are based on data published today (August 18) by the BoJ – the first in a new series of quarterly releases. Overall, the data shows liquidity in the Japanese government bond (JGB) market is sound, Nakaso said in an interview with Risk.

"We think these data clearly indicate there are no serious problems with the liquidity and functioning of the JGB market nor does it seem likely that the liquidity in the JGB market has declined to the extent that it makes a continuation of our large purchase of JGBs difficult," he said.

Liquidity in the Japanese government bond (JGB) market has been a hot topic since the central bank surprised markets by expanding its two-year old programme of quantitative and qualitative easing (QQE) in October last year. At the time, a hike in the domestic consumption tax, coupled with a drop in oil prices, had been exerting downward pressure on prices – threatening the BoJ's 2% inflation target.

Under the expanded QQE programme, the BoJ aims to purchase around ¥80 trillion ($643 billion) of JGBs annually – roughly twice the planned new issuance of bonds for 2015, which means the central bank has to hoover up a vast amount of bonds via the secondary market.

We have seen some deterioration in market depth and market resiliency. So this is something we've got to monitor carefully going forward

The fear in some quarters is that available supply will dwindle to the point that very little actual trading takes place. In May, a study by four researchers in the BoJ's financial markets department found JGB liquidity had been declining, based on an analysis of government bond futures trades – and the central bank is using some of the same indicators in its new series of data releases.

Trading volumes in the JGB futures market are at "a good level", said Nakaso, with bid/offer spreads also fairly tight, except for a prolonged spike following the introduction of the QQE programme in April 2013.

Other indicators, though, show conditions have worsened.

"This does not mean we can be pleased about the JGB market. We have seen some deterioration in market depth and market resiliency. So this is something we've got to monitor carefully going forward," he said.

Market depth – as measured by the volume of JGB futures trades completed at the best available offered price – slipped from highs of around 200 in the middle of last year to between 25 and 50 during 2015.

Market resilience – measured in terms of the price impact of JGB futures trades – has also suffered, with trades this year producing bigger price movements than at any time since QQE was announced.

Nakaso said the BoJ could try to arrest further deterioration: "There are a couple of things we can do as a central bank. First of all, we should focus on the improvement of market practices and, second, we should also look at the improvement of market infrastructures."

In terms of market practices, Nakaso pointed to the key messages from a repo market forum held by the BoJ in May. The central bank was urged to bring the market to a same-day settlement standard, and also to advocate term repo trades.

In terms of market infrastructure, the BoJ is already working on upgrades to its BoJ-Net settlement system, which will take effect in October. From February, the system will remain open each day until 9pm local time.

"This will enable the BoJ-Net to cover both Asian and European time zones. It's partly intended to facilitate a more efficient management of JGB to be used as collateral on a cross-border basis," Nakaso said. In particular, it would be easier for foreign clearing houses to accept JGBs as margin, he added.

Nakaso conceded these measures may not be enough, on their own, to ensure the JGB market remains liquid, but said they would "make JGBs more widely used, and that would be a significant step forward."