Market Implications of Recent Changes in Japanese Monetary Policy

by: SA Editors

Morgan Stanley economist Takehiro Sato discusses market implications of the Bank of Japan's recent change in monetary policy:

With US long-term yields backing up, oil prices softening and emerging market spreads widening, the expansion of liquidity worldwide appears to be slowing. However, we believe it is incorrect to link this trend with concerns about a contraction in liquidity because of the BoJ’s latest policy move.

Indeed, the Japanese stock market has come under pressure because of these concerns (and in particular an unwinding of the yen carry trades) and the possibly of rate hikes, but the credit ratings of Japanese banks, which supplied substantial amounts of yen funds at a negative carry to much more creditworthy foreign banks in 1998, have improved substantially.

We thus have some doubts about whether substantial yen carry trade positions have built up, as in 1998. During our recent visit with European investors, including a number of hedge funds, they all said they had not engaged in yen carry trades. In addition, since the BoJ intends to continue to passively supply substantial amounts of liquidity in response to market demand, to keep the overnight call rate at effectively 0%, we think that any near-term market pullback because of liquidity concerns would be a buying opportunity...

We see little likelihood of domestic and overseas investors’ commitment to Japan weakening or the markets coming under pressure from a downturn in stocks, bonds and the yen because of liquidity drying up with the BoJ’s latest policy move. Our equity strategist acknowledges that valuations are somewhat high, but still considers the market attractive in terms of the momentum of change and in light of the pullout from deflation.

The decision to end quantitative easing reflects the BoJ’s belief that deflation will not come back again, which should not be a negative for Japan’s asset markets. Also, a slight rise in the policy rate makes it unlikely that investors’ risk preferences will change immediately. We need to remember that the BoJ’s policy rate in the bubble years was 2.5%, much higher than it is now.

See Takehiro Sato's full analysis.