* BOJ and markets have different views on inflation,
* Neither side is likely to change their views in near
future, leading to market stalemate
* Market volatility, now at historic lows, will likely jump
later this year
By Hideyuki Sano and Lisa Twaronite
TOKYO, May 29 "I hear but I don't listen to,"
Wim Duisenberg, the first president of the European Central
Bank, famously said in 2001 when asked about pressure to cut
More than a decade later in Japan, it is financial markets
that hear but do not listen to the central bank, and the
perception gap between the two is likely to lead to a huge spike
in market volatility down the road.
Although the Bank of Japan has beaten the drum for its
optimistic economic forecast in the past several weeks, playing
down the need for additional stimulus, financial markets have
hardly reacted, with many investors still sticking to hopes of
"At the moment, there's about a 70-30 split between people
still looking for the BOJ's second round of easing and those who
are not looking for the BOJ to move until autumn or towards the
end of the year," said Shogo Fujita, chief Japan bond strategist
at Bank of America Merrill Lynch.
Even as one of the BOJ's most dovish board members, Deputy
Governor Kikuo Iwata, went so far as to mention possible
tapering in the BOJ's massive asset purchases this week, markets
gave the notion a cold shoulder, with the yen, Japanese bonds
and stocks showing no reaction.
"The BOJ thinks Japan's inflation is on course to hit the 2
percent target. Markets think 2 percent will be difficult
without additional easing. At some point in the future, either
the BOJ or markets will have to correct their views. That's when
volatilities are likely to rise," said a senior currency option
trader at a major Japanese bank.
For now, neither the BOJ nor markets are ready to concede,
having good reason to believe in their own scenarios.
The central bank says inflation has been rising in line with
its projection and that the jobless rate has fallen steadily to
3.6 percent, a level some economists think is close to full
employment - where companies will be forced to increase wages to
Many investors think, however, the rise in inflation so far
is caused mostly by the yen's weakening, the impact of which is
expected to wear off from now. Some investors also question if
domestic consumption will recover as quickly as the BOJ expects
from the blow of a sales tax hike in April.
Both sides agree that inflation will plateau around 1.3
percent for the next months and the difference lies in what will
happen after that, which suggests the final verdict is still a
few months away.
This has resulted in stalemate in markets, with volatility
in the yen, Japanese bonds and stocks markets falling to
The yen's actual volatility in the past month was around 4
percent, near its 2007 low. JGB futures' volatility is a mere 1
percent, also near a record low hit in 2012. Stock volatility
has fallen sharply over the past few months.
Option markets are also pricing in a very low level of
market fluctuation. One-month implied volatility on dollar/yen
options hit a record low around 5.5 percent this
Traders say speculators have shown scant interest in buying
options even as they have become so cheap, because none of them
can come up with a plausible scenario for rising market
volatility just yet.
But that could change in a few months.
If the BOJ is indeed right on inflation, then its buying of
government bonds and some riskier assets will need to be scaled
back, and the impact on JGBs would be huge.
So far this fiscal year from April, the 10-year JGB yield
has moved in a narrow nine-basis-point range around 0.6 percent.
"If you look back, it's not uncommon that the JGB yield
moves about one percentage point within a few months. A move of
that magnitude happens once every 10 years or so. It's hardly a
tail risk," said the head of fixed income at a U.S. brokerage
(Reporting by Hideyuki Sano; Editing by Kim Coghill)