Bank of Japan Torches Global Markets, Sparks Global Sell-Off

The Bank of Japan failed to meet market expectations overnight as the central bank kept policy constant. Markets were expecting the Bank to extend the maturity on the cheap loans it has been making and the failure to do so sparked a global sell-off.

Funding Facility Untapped

The failure for the Bank of Japan to extend the 1-year funding facility it has used to keep bond yields from spiraling higher shocked markets and sent stocks reeling. The bank has tapped the facility seven times amid a surge in bond yields to try to stem the gains but Governor Haruhiko Kuroda said that the Bank of Japan would consider longer funding facilities "if they become necessary."

The Bank announced that the funding facility will go ahead as scheduled and under the framework set up by previous Governor Masaaki Shirakawa. Kuroda said that the BoJ is set to extend 3.15 trillion yen ($32.5 billion) of loans to 70 of the nation's largest banks on June 20.

First used on April 20 to ease the volatility in bond markets following the BoJ's pledge to double the monetary base over two years, the BoJ has now 13 trillion yen ($134.02 billion) of 0.1 percent short-term loans. Banks and financial institutions have taken just over 10.4 trillion yen ($107.22 billion) of the loans.

Upgraded Forecast

The Bank of Japan did, however, upgrade its forecast for the economy, as expected. The BoJ caught up to markets perceptions of where the economy is heading following the stronger than expected GDP and inflation data released late Sunday.

"With regard to the outlook, Japan's economy is expected to return to a moderate recovery path," the Bank said in its statement, "mainly against the background that domestic demand increases its resilience due to the effects of monetary easing as well as various economic measures, and that growth rates of overseas economies gradually pick up, albeit moderately. The year-on-year rate of change in the CPI is likely to gradually turn positive."

The Bank also sees better activity abroad as exports pick up. "Japan's economy has been picking up. As for overseas economies, while the manufacturing sector continues to show a lackluster performance, they are gradually heading toward a pick-up as a whole. In this situation, exports have started picking up."

"Private consumption has remained resilient, assisted by the improvement in consumer sentiment. Reflecting these developments in demand both at home and abroad, industrial production has been picking up. Meanwhile, financial conditions are accommodative."

Bond Market Volatility

Japanese 10-year bond yields have swung wildly in the last few months following the announcement of the super-aggresive policy stance. After bottoming below 0.5 percent, bond yields rose quickly to 0.65 percent in April after the decision. Yields have continued to rise from there to the current 0.88 percent after peaking above 0.9 percent.

2-year bond yields have seen similar volatility over the span, having nearly quintupled since the Bank of Japan committed itself to beating deflation. The moves in bonds raise fears that the Bank of Japan may have done too much too quickly and could lose control of the economy, setting off a wave of uncontrollable inflation.

Equities Decline

Global equities declined on the news, with the Japanese Nikkei 225 Index declining 1.45 percent. Japan's Topix Index also fell 0.97 percent while the Hang Seng Index declined 1.2 percent in Hong Kong. Nikkei futures extended losses in early New York trading.

European shares fell sharply following the news. Spain's Ibex 35 Index fell 2.44 percent and Italy's FTSE MIB Index fell 2.16 percent. In Germany, the DAX Fell 1.75 percent while French shares declined 1.99 percent and the FTSE 100 Index in London fell 1.74 percent.

U.S. equity futures also sagged on the news. S&P 500 futures fell 12.50 points or 0.76 percent to 1,629.50.

Currencies In Flux

Currency markets were on the move overnight as the yen gained against major currencies. The USD/JPY extended loss to nearly 2 percent to 96.88, down 188 pips. The yen also gained strongly against the euro and rose a massive 3 percent against the Australian dollar in early trade.

Aussie weakness was another major theme in currency markets overnight, partially attributing to the outsized weakness of the AUD/JPY rate. The Aussie extended recent losses against the U.S. dollar, the euro, and the yen.