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Twilight for QE in the land of Rising Sun

Twilight for QE in the land of Rising Sun

Monetary lore implores us to not fight the Fed. Rash bond traders, encouraged by a lull in official purchases, recently discovered a less well-known addendum to that: don’t battle the BoJ.

Testing the limits of the Bank of Japan’s three-month-old but still largely untested commitment to maintain the slope of the curve, and emboldened a year-high on the JGB 10-year yield, trading in the benchmark gapped almost 20% higher last week, from 0.11% to 0.143%.

After a month of relatively little activity, the BoJ clearly felt this was where it had to draw a line, responding with an unambiguous ¥450 billion (£3.2 billion) of buying, purchasing the 10-year at 0.11%. The acquisitions between 5-10-year took the schedule of recent buying over five years duration for the first time. 

That was enough to wipe out the yield expansion, and pinched shut at the short end an earlier circa-50bps of widening along the curve. ‘This is the second announcement on the fixed-rate JGB purchase operation, but this shows a stronger commitment to yield curve control than [previously],’ said Nomura global FX strategist Yujiro Goto, adding it is a first suggestion of where it will defend prices. 

‘In fact, governor Kuroda said today that the BoJ still has a way to go to hit the target and so a continuation of its powerful easing is appropriate.'

While money talks more loudly than official communique, there remain many out there sceptical of how far the BoJ will be able to follow its current path, however. The reluctance of the BoJ to intervene earlier, following three months of yield curve pressure, which have lifted the 10-year from sub-zero in early November, suggests the bank appreciates that it has to make every bullet count.

The push higher in yields, which drew an official response appears to have been encouraged by an unexpected (and unexplained) reduction in monthly auctions in January, from a recent figure of six, to five. This was the first fall in frequency since Japan launched.

The bank has also increased its ownership of the JGB market to the point where it may soon find it no longer has much room to manoeuvre.    

‘The Bank already owns nearly 40% of all outstanding JGBs, and closer to 50% if we exclude holdings of insurance firms which have remained very reluctant to sell,’ said Marcel Thieliant, Japan specialist at Capital Economics.

‘With the pool of available JGBs drying up, we think that the Bank will scale back the volume of purchases from the current ¥80 trillion to ¥75 trillion this year. That said, policymakers will want to avoid the impression that a reduction in the volume of purchases is a signal of policy tightening. One way to do so would be to drop the explicit purchase target altogether and put the sole emphasis on the yield target instead.’

While such voices are increasing in volume, as of yet they remain the dissenting opinion versus a consensus which still expects policy makers to continue to lean hard into easing. Nonetheless, they are likely to continue to get louder should the economy continue its late-2016 trajectory.

The BoJ last week upgraded its growth estimates over each 12 year of its three-year forecast horizon to reflect the increasing momentum in Japan’s production, inventory and credit cycles, saying it now expected
the country to experience a consistent ‘moderate expansion’. 

Reflecting the extremely wide spectrum of possibilities opened by Japan’s unconventional policy position, Société Générale cross-asset specialists Tajuli Aida and Arata Oto, said they expected the BoJ to actually fight the incoming tide of rising rate expectations, at least for the foreseeable future.

‘With momentum for a cyclical economic recovery strengthening and US interest rates rising against the backdrop of increased expectations of further Fed hikes, the fair value of Japan’s long-term interest rate has started to increase,’ they wrote.

‘In order to keep JGB yields within the target range, the BoJ will likely need to continue its purchasing programme to combat the upward pressure on JGB yields created by the increase in fair value.

‘In order to further strengthen the move toward a complete exit from deflation, we continue to believe the BoJ will need to increase its purchase of JGBs from the current roughly ¥80 trillion per annum to ¥90 trillion per annum some time in 2017 in order to continue to keep long-term yields suppressed at the target rate of around 0%.

‘As Japan’s long-term yield remains suppressed and US yields rise, this will increase the spread between the two. Combined with the increased purchase amount, these effects will likely act as a slight additional easing. As a result, the yen should depreciate further and give additional support toward a complete exit from deflation.'

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