The Japanese economy continues to trudge along at an unremarkable pace, weighed down by what could be summarized as the four Ds: deficits, debt, deflation, and demographics. For more than 20 years, the country's policy makers have thrown everything but the kitchen sink at the economy in an effort to boost growth. The deficits and debt that have resulted from these policies have neither sparked an increase in consumption nor countered deflationary forces. All the while, the country's population distribution has gotten older, leading a greater percentage of Japanese to put a priority on saving instead of spending. In thinking about what government action might constitute the proverbial kitchen sink, we provide an updated perspective on Japan to account for some recent developments.
In late September, the Bank of Japan (BoJ) announced an overhaul to its policy focus, stating that controlling the yield curve was now central to its plans. In addition to controlling short-term rates, which the bank pushed into negative territory early in 2016, the BoJ will now control rates on the long end of the curve. BoJ Governor Haruhiko Kuroda stated that the bank would target a near-zero yield for 10-year Japanese government bonds (JGBs), which yielded just below zero at the end of the third quarter.
With this policy change, the BoJ could be signaling that it is open to the government pursuing a massive-scale fiscal policy agenda moving forward. Saying it will keep the 10-year yield at zero means the BoJ is committed to buying all the JGBs required to hit that target. In effect, the bank's bond purchases will now be tied directly to how much debt the government issues. The BoJ currently is purchasing ¥80 trillion (about $710 billion) of government debt each year; it has not announced an official change to that policy, but the 10-year yield target indicates it will purchase more if necessary (it also means it could purchase less if that would maintain the near-zero yield).
Although purchasing government debt is nothing new for the BoJ, the wrinkle that makes this latest policy change unique (and perhaps a "kitchen sink" policy) is that in effect the state's monetary policy would be determined by the government's spending needs versus the needs of the economy. This approach to debt monetization could fall under the heading of "helicopter money," which has been a hot topic in financial media recently.
We do not believe that yield targeting on its own makes it easier to generate economic growth or inflation. There continue to be serious structural issues within Japan's economy, and Prime Minister Shinzo Abe's economic policy agenda, known as "Abenomics," has not addressed these issues and has fallen flat. Our base case remains that there will be no meaningful acceleration in growth or inflation in Japan, and that the key monitoring point is inflation expectations. If Japan were able to generate inflation, real yields would move lower given that nominal yields are fixed. All else being equal, this would cause the yen to weaken, helping exporters and corporate profits.
For now, we remain cautious on Japan. We continue to pursue selective opportunities levered to secular growth trends as opposed to Japanese macroeconomic growth. To become more bullish on Japanese equities, we would need to see positive rates of change relative to deflation and public debt/deficit reduction, as well as structural reforms aimed at reducing demographic headwinds.