Traders eye chance of more BOJ tweaks
Investors are on high alert for further policy tweaks from the Bank of Japan this week after December’s shock decision to raise the bar on yield movements failed to significantly improve market liquidity.
While almost all economists surveyed by Bloomberg expect no change at the two-day meeting finishing today as their main scenario, market pressure on the central bank’s stimulus framework has intensified since last month’s efforts to ease the side effects of policy.
Another increase in the ceiling for the 10-year yield is seen as the most likely course of action, should the BOJ act, given its recent emphasis on improving bond-market functioning.
But strategists say even that may not be enough to stem the strains on the framework and its side effects over the coming months as speculation over a policy shift under a new leader grows. Governor Haruhiko Kuroda is due to step down in April with the justification for his decade-long stimulus increasingly called into question as inflation sets four-decade highs.
“Pandora’s box has been opened and it will be very difficult to contain at a time when the global backdrop has meaningfully shifted on a number of fronts,” TD Securities strategists, including Mazen Issa and Priya Misra, wrote in a recent note. “Markets should potentially be prepared for a 1% 10-year yield cap by the time Kuroda exits.”
Investors are trying to gauge when the world’s boldest experiment with ultra-loose monetary policy will come to an end, a shift likely to have repercussions far beyond Japan’s shores.
It’s an exit that involves untying a Gordian knot of negative short-term interest rates, a cap on 10-year yields and massive asset purchases without upending markets. Higher borrowing costs would also impact the government’s financing of the developed world’s largest public debt load just as it ramps up defence spending.
Kuroda blindsided traders on Dec 20 by doubling the upper limit on benchmark bond yields. But if tackling liquidity issues in the local market was the goal, it’s had the opposite effect. Bidask spreads for government bonds, a gauge of liquidity, have widened since the tweak as yields climbed to the new ceiling and beyond.
The BOJ has had to once again ramp up its debt purchases to defend the higher cap, hoovering up even more of a market where it is now the majority owner.
The 10-year bond yield rose above its 0.5% ceiling for a second day on Monday before erasing its advance. The central bank bought ¥2.1 trillion ($16.4 billion) of government bonds Monday after spending almost ¥10 trillion defending its stimulus framework on the final two days of last week.
A visible dislocation in Japan’s yield curve has also yet to disappear with yields on eight- and nine-year notes remaining above their 10-year equivalents. Officials will review the side effects of their policy at this week’s meeting and will make further adjustments if necessary, the Yomiuri newspaper reported last week.
“Market functioning is deteriorating further as a result of the BOJ’s increased bond buying,” said Eiji Dohke, chief bond strategist at SBI Securities Co in Tokyo. But, “should the BOJ stop its aggressive buying, it will rekindle memories of the abrupt end of the Reserve Bank of Australia’s yield target, further fanning speculation of BOJ policy tweaks.”
Outside the bond market, there are other possible reasons for the BOJ to reconsider its easy policy. Japan is experiencing the hottest inflation in decades with price growth in Tokyo, a leading indicator for the nation, running at 4%, double the central bank’s target.
Even with inflation above target, Kuroda has insisted that stimulus must stay in place. The BOJ expects cost-push price gains to cool below target in the year starting April and says sustainable wage growth must emerge first to ensure Kuroda’s decade-long goal of lasting inflation is reached.
BOJ watchers will be keeping a close eye on the preliminary results of the annual spring wage negotiation talks, typically released around mid-March.
Nippon Life Insurance Co and Suntory Holdings Ltd are among Japanese blue chips that have already flagged plans to raise wages above the level of inflation. Last week Uniqlo clothing brand owner, Fast Retailing Co, said it will raise annual pay for full-time employees in Japan by as much as 40%.
“Fast Retailing is one of the front runners of Japanese corporates to shift Japan from a deflation economy to a normal moderate-inflation economy,” said Rie Nishihara, chief Japan equity strategist at JPMorgan Chase & Co and a former analyst at the BOJ.
If the results of the spring wage negotiations prove strong and inflation remains high, BOJ policy making can become more flexible under a new governor, she added.
Still, some strategists believe the central bank won’t move again until there is more clarity on its new leadership.
For Goldman Sachs Group Inc, the possibility of a global economic slowdown and recession in Japan, and the risk of higher interest rates to a growing number of debt-laden small-andmedium size companies could also stay the central bank’s hand.
“The December decision significantly lowered visibility on the monetary policy outlook, and therefore see an increased risk that the BOJ may have to abandon YCC abruptly if defending it becomes unsustainable,” a team including Allison Nathan wrote earlier this month.
Hideo Hayakawa, a former BOJ executive director, offers another reason why the BOJ will keep its yield framework unchanged this week. He says another move now would be too “embarrassing” as it would suggest not enough had been done in December.
Traders in the derivatives market are still betting the central bank will shift. Ten-year swap rates, popular among international funds, rose to 1% last week, well above the BOJ’s 0.5% ceiling for the benchmark bond.
“We are taking positions for a possible rise in yields,” said Shinji Hiramatsu, general manager at Sompo Asset Management Co. “The likelihood of a policy change this month is low, but we can’t rule it out totally.”