Fiscal Confidence Shocks and the Market for the Japanese Government Bonds

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1 HIAS, IER and AJRC Joint Workshop "Frontiers in Macroeconomics and Macroeconometrics November 3 4, 2017 Fiscal Confidence Shocks and the Market for the Japanese Government Bonds Etsuro Shioji (Hitotsubashi) 1

2 Acknowledgement Research for this work has been funded by MEXT through the Hitotsubashi Institute for Advanced Study (HIAS) Grant in aid for Scientific Research A 17H00985 C 15K03418, Nomura Foundation. 2

3 Objective Identify news that might have changed people s perception about fiscal sustainability in Japan. Examine if there is any sign that the JGB market has responded to those shocks. We look at JGB Futures Index, and JGB VIX. 3

4 Structure of talk 1. Background 2. What this work does 3. News Analysis 4. A first look at the Data 5. Estimation results 6. Work ahead 4

5 1. Background 5

6 Japan faces a mounting public debt Japan 6

7 but the Japanese Government Bonds (JGBs) Market seems to remain calm. Sep 16 Sep 74 Sep 76 Sep 78 Sep 80 Sep 82 Sep 84 Sep 86 Sep 88 Sep 90 Sep 92 Sep 94 Sep 96 Sep 98 Sep 00 Sep 02 Sep 04 Sep 06 Sep 08 Sep 10 Sep 12 Sep Y 10Y

8 How can this happen?! No sign of increased risk premia. < > literature on sovereign default risk; FTPL with long bonds One of the seven wonders of the Japanese Economy! 8

9 Heated debate in Japan Some economists (and MOF): call for a fiscal reform The JGB market might crash! Others: dismiss those concerns. The opponents are boys who keep crying wolf. 9

10 Popular explanations Confidence in fiscal discipline Somebody will eventually take the responsibility JGBs are held mostly by domestic agents. (Japan, as a nation as a whole, maintains a positive Net Foreign Assets.) If the government goes bankrupt, the entire economy collapses, so nothing is safe, anyway (Sakuragawa & Sakuragawa 2017). JGBs always remain safe in the relative sense. (People expect the BOJ will sustain the value of JGBs. This explanation may be relevant for recent years.) 10

11 2. What this work asks (and studies) 11

12 Question: does the market really NOT price the default risk AT ALL? Even if the popular hypotheses in the previous page explain the general trend in the market we expect that a marginal change in the likelihood of debt sustainability should be reflected somewhere in the market..... unless the standard theory is completely useless! 12

13 Where do we look? (1) Look for events or news that should have changed people s perceptions about debt sustainability (News Analysis). 13

14 Where do we look? (2) Instead of the spot JGB rate, look at JGB futures. The market is more liquid. Also, look at JGB VIX. Perhaps we can detect a slight change in higher (second) order moments in people s subjective beliefs about sovereign default. 14

15 Related literature to be added by the time of the conference New Analysis of Monetary Policy Effects Fiscal Policy in Japan Policy Uncertainty Index for Japan 15

16 3. News Analysis

17 Read Newspapers carefully > Create a list of news that (might) have changed the public s confidence in fiscal sustainability. Newspapers = Nikkei & Asahi

18 JGB yields (10 years) and recent history of the Japanese government LDP DP LDP Aso Kan Noda Abe Fuku Hato da yama 0.5 Jan 08 Jan 10 Jan 12 Jan 14 Jan 16 Fukuda Aso Hatoyama Kan Noda Abe 10Y 18

19 Fiscal news dates Jun 08 2 Jun 09 2 Jun 10 2 Jun 11 2 Jun 12 2 Jun 13 2 Jun 14 2 Jun 15 2 Jun 16 2 Jun 17 fp jgb10y 19

20 2 PM = Fukuda and Aso PM Fukuda comments in favor of CT hike. Fukuda resigns and Aso takes over. Aso turns in favor of CT hike. Fight over future plan for CT hike, results in the "Supplementary Clause". Largest Stimulus Package in history. DP defeats LDP in a landslide. 0 2 Jun 08 2 Aug 08 2 Oct 08 2 Dec 08 2 Feb 09 2 Apr 09 2 Jun 09 2 Aug 09 Note: CT refers to Consumption Tax. fp jgb10y 20

21 PM=Hatoyama DP overturns the budget process that was already ongoing. "Shiwake"; Stimulus Plan eats up all the money saved. Big internal fight within DP over budget, resulting in the Ozawa Initiative. FM Kan comments in favor of CT hike. Hato yama quits. 0 1 Sep 09 1 Nov 09 1 Jan 10 1 Mar 10 1 May 10 fp jgb10y 21

22 PM = Kan Kan takes over but loses election; no more mention of CT hike. Budget plan to be discussed starting June. Recovery bonds. Plan for Fiscal reform approved. 0 4 Jun 10 4 Aug 10 4 Oct 10 4 Dec 10 4 Feb 11 4 Apr 11 4 Jun 11 4 Aug 11 fp jgb10y 22

23 PM = Noda Noda pushes for CT hike, big DP infighting. CT Bill is pushed through within DP, a big division within the party. Noda forms a coalition with LDP and CT Bill is approved by the Lower House. CT Bill almost fails but is finally approved by the Upper House. Abe takes over in LDP. Noda dissolves the Lower House and Abe wins in a landslide Aug Oct Dec Feb Apr Jun Aug Oct 12 fp jgb10y 23

24 PM = Abe Big Fiscal Stimulus, but target for PB maintained. "Hone buto" Abe decides to go ahead with CT hike (8%) as planned. Abe postpones the second CT hike (10%). 0 fp jgb10y 24

25 PM = Abe, continued Abe postpones the CT hike again. Pension Reform Bill passed. New target for fiscal balance introduced fp jgb10y 25

26 4. A First Look at the Data 26

27 Left hand side variables JPX JGB Futures Index (10 year bonds) S&P/JPX JGB VIX Index I use daily data throughout this presentation. 27

28 JGB Future Index jan jan jan jan jan jan

29 JGB Futures, Log first difference jan jan jan jan jan jan

30 JGB VIX jan jan jan jan jan jan

31 JGB Futures vs Foreign variables As the next figures show, there seem to be nonnegligible spillovers from abroad. 31

32 Government Bonds Futures Indices, US vs JPN log differences from 40 business days ago jan jan jan jan jan jan2018 JPN US US = S&P U.S. Treasury Bond 7 10 Year Index 32

33 Government Bonds Futures Indices, Eurozone vs JPN log differences from 40 business days ago jan jan jan jan jan jan2018 JPN EUR Euro area = S&P Eurozone Sovereign Bond Index 33

34 JGB Futures vs Exchange Rate (JPY USD) log differences from 40 business days ago jan jan jan jan jan jan JGB Futures JPY-USD rate, right axis Euro area = S&P Eurozone Sovereign Bond Index 34

35 JGB VIX vs Foreign variables 35

36 Government Bonds VIXs, US vs JPN 5 days moving averages jan jan jan jan jan jan2018 JGB VIX US Treasury Note VIX US = CBOE/CBOT 10 Year US Treasury Note Volatility Index 36

37 JGB VIX vs Exchange Rate VIX (JPY USD) jyvixavg 01jan jan jan jan jan jan2018 JGBVIX JYVIX (JPY-USD), right axis 37

38 Other variables of interest 38

39 Foreign Monetary Policies Fed & ECB policy announcements and speeches Fed: Fawley & Neely (2013), Gang (2017) ECB: Ambler & Rumler (2016) 39

40 BOJ policy announcements QQE QQE Expanded Negative Rate Yield Curve Control Jun 08 2 Jun 09 2 Jun 10 2 Jun 11 2 Jun 12 2 Jun 13 2 Jun 14 2 Jun 15 2 Jun 16 2 Jun 17 mp jgb10y call rate 40

41 others Dummies for several days following the Great East Japan Earthquake (march 2011). 41

42 5. Estimation results 42

43 Estimation details Method: OLS (GARCH with dummy variables never converged ) Data frequency: daily (no weekends) Sample period: JGB Futures: January 2009 June 2017 (T=2217) JGB VIX: January 2008 August 2017 (T=2001) Lag length chosen by AIC. All the FED and ECB dummies are lagged by one business day (due to time difference). 43

44 Regression 1 LHS=JGB Futures (log 1 st diff.) coeff. t-value JGB Futures (log diff., lag 1) US Bond Futures (log diff., lag 1) same (lag 2) same (lag 3) EU Bond Futures (log diff., lag 1) same (lag 2) JPY-USD (log diff., lag 1) USD-EUR (log diff., lag 1)

45 Only two Fed dummies appeared significant: May 1, 2013 = FOMC, first sign of tapering May 22, 2013 = Bernanke tapering speech Three ECB dummies were significant: May 7, 2009 = first Longer Term Refinancing Operation (LTRO) announced. Aug 8, 2011 = second Securities Markets Program announced. Jan 22, 2015 = Asset Purchase Program. 45

46 Significant BOJ dummies March 18, 2009 December 1, 2009 April 4, 5 and 9, 2013 (QQE) January 29, 2016 (Negative Interest Rate Policy) September 21, 2016 (Yield Curve Control) Earthquake dummies turned out to be significant. 46

47 Significant Fiscal Policy Dummies Abe postpones the CT hike! Noda Ozawa fight within DP over CT hike Jun 08 2 Jun 09 2 Jun 10 2 Jun 11 2 Jun 12 2 Jun 13 2 Jun 14 2 Jun 15 2 Jun 16 2 Jun 17 fp jgb10y Only ten remained and half of them were during 2009!! 47

48 Regression 2 LHS=JGB VIX (level) coeff. t-value JGB VIX (lag 1) same (lag 2) same (lag 3) US Bond VIX (lag 1) same (lag 2) same (lag 3) JPY-USD VIX (lag 1) (continued on the next page) 48

49 continued coeff. t-value JGB Futures (log diff., lag 1) when positive JGB Futures (log diff., lag 1) when negative JPY-USD (log diff., lag 1) JPY-USD (log diff., lag 1) SQUARED US Bond Futures (log diff., lag 1) EU Bond Futures (log diff., lag 1)

50 Three Fed dummies were significant: December 12, 2012 = FOMC, Fed will continue to buy treasuries. (+) May 1, 2013 = FOMC, first sign of tapering ( ) May 22, 2013 = Bernanke tapering speech (+) Only one ECB dummy was significant: Jan 22, 2015 = Asset Purchase Program (+) 50

51 Significant BOJ dummies February 19, 2009 (CP&CB buying extended) ( ) October 30, 2009 (Special Funds Supplying Operations (SFSO) extended) ( ) December 1, 2009 (SFSO to expire as scheduled) (+) April 27, 2012 (Bond purchases expanded) ( ) April 4 and 5, 2013 (QQE) ( & +) January 29, 2016 (Negative Interest Rate Policy) (+) September 21, 2016 (Yield Curve Control)( ) Earthquake dummies were mostly significant. 51

52 Significant Fiscal Policy Dummies Abe postpones the CT hike! Noda Ozawa fight within DP over CT hike Jun 08 2 Jun 09 2 Jun 10 2 Jun 11 2 Jun 12 2 Jun 13 2 Jun 14 2 Jun 15 2 Jun 16 2 Jun 17 fp jgb10y 52

53 6. Summary and Work Ahead 53

54 Summary It is hard to find fiscal news that was priced in the JGB market For JGB Futures: most significant news were in When the interest rate was still above zero. And the market was still in turmoil. For JGB VIX: results were more even. Still, two episodes stand out: In : In fighting within DP over the proposed consumption tax hike. In 2014: Abe postpones a scheduled consumption tax hike. 54

55 Work ahead If even VIX does not respond, should we conclude that the market is just not interested in fiscal policy? NOT YET. Where else to look? Higher order moments, tail risk. Liquidity measures. (Need high frequency data!) 55

56 Appendix Comparison of JGB VIX with other types of VIXs 56

57 JGB VIX vs the VIX (US stocks) jan jan jan jan jan jan jan2018 JGBVIX VIX (US), right axis 57

58 JGB VIX vs VSTOXX (European stocks) jan jan jan jan jan jan jan2018 JGBVIX VSTOXX (Europe), right axis 58

59 JGB VIX vs EUVIX (USD EUR) jan jan jan jan jan jan jan2018 JGBVIX EUVIX (USD-EUR), right axis 59

A New Daily Indicator for Fiscal News in Japan

AJRC-HIAS, March 21-22, 2016 @ ANU A New Daily Indicator for Fiscal News in Japan Etsuro Shioji (Hitotsubashi) (Hiroshi Morita (JSPS) to be added as co-author, in future) 1 Overview of the ennre project