The BOJ Positions For The Fed And The ECB

by: Adam Whitehead


The BOJ is positioning itself in relation to the Fed and the ECB.

Consensus for further BOJ monetary policy easing is conditional upon the Policy Board forecasting lower future growth and inflation.

The BOJ may first take years to convince the Japanese public that it will never exit QQE before easing further again.

The BOJ has the upper hand overthe MOF in the reflation fight.

Conditions precedent to ease BOJ monetary policy further are being signaled and ticked off.

In the week when the Fed and the ECB are widely expected to give their respective guidance, over the direction of their monetary policies for the immediate future, the perspective from the BOJ's viewpoint is an interesting one to take.

Great attention has been given to the impact of the Fed's current gradual march towards the neutral rate of interest on emerging markets. Perhaps the BOJ is mindful of what this means for Japanese monetary policy also.

There is also great expectation that the ECB will signal the end of QE at its upcoming Governing Council meeting. Perhaps the BOJ is similarly mindful of what this means for Japanese monetary policy.

Whilst it waits and watches its central bank colleagues, the BOJ may also be loading a few tricks of its own up its sleeves to cope with the aftermath.

Worry over the real intentions and capabilities of BOJ Governor Kuroda continue to plague Japan watchers. The new cause for concern is the dramatic slowing of the pace of ETF purchases, since he was reconfirmed. Some take this to mean that Qualitative Easing has now been tapered. What emboldens this view, is the fact that no verbal guidance has been given in line with this change in purchases. Similarly, no guidance was given when the BOJ abruptly terminated its blanket JGB purchases across the yield curve as it switched to a process of yield curve targeted purchases instead. The BOJ has become opaque in its communications about changes in its behavior. Observers who are used to being spoon-fed with guidance have become unsettled.

Mr. Market has become impatient with Mr. Kuroda, but Mr. Kuroda may have time on his side as he figures out how to get the Fed and the ECB onside.

The Fed's arrival at the neutral rate could have the impact of strengthening the Yen again, if it is framed as the end of the normalization rather merely a pause. This event has to be thought about and prepared for. The June FOMC meeting will provide the BOJ with some more food for thought; to chew and to reflect on the taste.

The ECB's declaration of the end of QE may strengthen the Euro; although it must be said that the current weakness in the Eurozone economy is mitigating in the other direction. The market reaction to the June Governing Council meeting will be more important than what is said.

The last report observed the conundrum facing the BOJ, in the current environment of slow progress on the growth and inflation; combined with domestic political and global threats of economic softness weakened further by trade war friction. The BOJ's default on hold monetary policy position is a reaction this cocktail of risks and opportunities. Recently released minutes of the last BOJ monetary policy meeting, reflect this dynamic friction; with conflicting concerns expressed about the risks of continuing easy monetary policy versus the that of exiting QQE prematurely in the face of growing headwinds. There was considerable discussion of how to guide markets when the time for normalization comes, although it was agreed that this is still some way off.

If the BOJ was looking for an excuse to collectively sit on his hands and do nothing, the recently published wages data certainly helped. Wages are now growing at the fastest pace in decades. More encouragingly, this is driven by an increase in full time rather than casually employed workers. So much for the good news.

(Source: Econoday)

The bad news is that the latest GDP data shows that the economy is now contracting quarter-on-quarter for the first time in two years. This is an ideal point from which to start building consensus to ease again, should Governor Kuroda wish to do so.

(Source: The Daily Shot)

Ominously, the positive signals from the labor market are tailing off. Job openings have been falling and the number of applicants has been flat-lining. Full time employment wages may be rising but this should be put into the context of a softening labor market.

The fear, within the BOJ monetary policy making board, that deflationary inflation expectations will take even longer to dislodge was discussed in the last report. It was noted that the BOJ may initially respond to this obstacle by simply maintaining QQE for even longer. This was viewed as a potential precursor to then expanding monetary policy even further, as a kind of pro-cyclical nudge to the dislodged inflation expectations.

Governor Kuroda as yet has given no strong hint that he is ready to start dislodging the deflation bias. When asked about the BOJ's commitment to yield curve targeting, Governor Kuroda responded in a way that caused his audience to assume that he is actually considering letting yields rise. He replied that "it's not as if we will defend the 10-year yield target of around zero percent at all costs," however he added that he had "absolutely no plan" to raise the yield target for the time being with inflation still distant from 2 percent.

The last report was also looking for signals that a consensus was forming to ease further if the economy and progress on inflation degenerated. It was noted that progress in this regard was thus far muted, based on a lack of negative forces combined with "moderate" growth and inflation drivers. The BOJ monetary policy board's published minutes did however show some slight progress on the easing consensus building process with the report that: "one member said that, with a view to reinforcing the inflation-overshooting commitment, it was appropriate for the Bank to introduce a new commitment that it would take additional easing measures if - with regard to the median of the Policy Board members' forecasts of the CPI in the Outlook for Economic Activity and Prices - there was a delay in the timing of achieving the price stability target due to domestic factors". Easing consensus building is therefore conditional upon official gloomy predictions from the Policy Board in the future. The bar to further easing is therefore a high one, but not insurmountable.

(Source: Seeking Alpha)

A former BOJ insider Kazuo Momma, who oversaw monetary policy and international affairs during his stint at the BOJ, recently provided a powerful and intuitive frame of reference; through which to view the current dilemma and future policy developments for the central bank.

Momma specifically focused on the BOJ's act of dropping its time-frame to achieve its inflation target at the last meeting, which this author noted as a sign of failure. For Momma this is a failure to change the entrenched deflationary perceptions of the Japanese public; in which he sees the dropping of the target as a pro-active step in the arduous task of changing said perceptions. In his view: "The BOJ has made clear it no longer has any time-frame in mind in guiding policy. That means it could maintain current policy for years if the price target remains elusive." If he is correct, it may take years to build consensus for a further easing as the BOJ first takes years to convince the Japanese public that it will never exit QQE.

As the curious Japanese ritual of consensus building at the BOJ proceeds at snail's pace, an even more laborious ritual consensus building process is underway between the BOJ and the MOF. In light of the political scandal surrounding MOF Czar Taro Aso, his institution has been shamed; and therefore its agenda to force more aggressive reflationary policies onto the BOJ has been undermined. Symbolic of this ritual humiliation, Finance Minister Aso genuflected to the victorious Governor Kuroda and publicly supported the case for yield curve targeting by the BOJ within the wider context of continued monetary policy easing. The victorious Kuroda magnanimously accepted Aso's surrender by replying that the MOF has made great progress in fiscal reform. He then punished his supplicant, as befits his elevated position of power, by calling for greater fiscal reform progress. Should such progress be forthcoming, he has informally guaranteed to respond magnanimously with further monetary policy easing.

Perhaps reflecting this new supine relationship of the Government to the BOJ, Prime Minister Abe's commentary about the central bank was less provocative than in the past. Abe now simply wishes the BOJ to operate in a manner that will lead to achieving the inflation target. Gone, is the criticism and the pressure to hit the target sooner.

The behind the scenes maneuvering, behind the public ritual face-saving, continued with the government officially approving the BOJ's decision to drop its inflation target achievement date. This symbolic loss for Kuroda has thus been framed as a collective national loss that is officially approved by the government. Accountability has also been conveniently wiped out for both the BOJ and the government, allowing them to live to fight another day. In return a joint declaration was signed by both the BOJ and the government to continue to work together; the BOJ to the inflation target at some time in the future as soon as it can whilst the government agrees to get its fiscal house in order. The joint declaration, on the face of it, is an agreement to draw a line under the recent hostilities and to work together again. With honors even and faces saved, the quid pro quo is clear. If the government makes progress on fiscal reform, the BOJ will respond with alacrity with easier monetary policy.

Governor Kuroda has clearly articulated his intentions and capabilities, based on current economic performance and future expectations, in his "Semi-annual Report on Currency and Monetary Control before the Committee on Financial Affairs". This report recorded the steady economic progress to date, with the observations that (a) inflation performance is still way below target and (b) there are clear global risks to the downside in 2019. Current QQE and yield curve targeting are therefore appropriate for what remains of this year, but in 2019 an easier monetary policy stance may be required.

Governor Kuroda then qualified the semi-annual report, with his own interpretation of the way forward. He chose to frame the glass as half-full, rather than half-empty as in the report. He promised that the BOJ will telegraph the ending of QQE and yield curve control well in advance; and only when the growth and inflation conditions make it possible. In his opinion: "For now, we don't think conditions are rife to consider specific timings for an exit" and "the BOJ won't end its ultra-easy policy before inflation reaches 2 percent."

Falling into line with the new Kuroda driven status quo, BOJ deputy Masazumi Wakatabe was the first central bank official to speak. He opined that, whilst he is confident that the current policy stance will achieve the inflation target, he is prepared to change his opinion if the data signals that a change is needed.

BOJ Board member Makoto Sakurai also conformed with Governor Kuroda's directive, whilst showing that he will be harder to persuade to ease further in the future. Sakurai is more concerned about the long-term structural damage, especially to the banking sector, that the current protracted period of ZIRP/NIRP is doing. If inflation rises further, he advocates considering scaling back the monetary stimulus.

The Cabinet Office also fell into line with Kuroda, in its latest assessment. Growth was assessed to have continued in May. Behind this charade of compliance however, policy makers were busy abandoning all forms of recent fiscal restraint. Perhaps this fiscal U-turn is in response to Prime Minister Abe's recent dismal political fortunes in relation to the corruption scandal. Whatever the reason, the result is that the cap on social security spending may be lifted alongside commitment to create a fiscal surplus. This new fiscal stimulus and slippage will thus need to be factored in to Governor Kuroda's monetary policy plans. The need for further monetary policy stimulus has been reduced somewhat. The government will have to show some token fiscal reform if it is to tempt Governor Kuroda to ease further.

With US-China trade negotiations and the thaw on the Korean peninsula getting the headlines, focus on Japan's trade issues with America have been overlooked by the markets. There was however a recent reminder, that things are not good on the US-Japan trade front, which the markets should pay closer attention to. The Japanese are the only American allies who did not have the blanket US metal tariff waiver applied to them. They are now considering reciprocating with tariffs of their own. Should they go ahead, the reciprocal Tweet from POTUS and market frenzy should then follow! More worrying will be the impact on all those Japanese cars that Americans buy.

The foreign exchange market has sent the signal to Governor Kuroda, that it understands his intentions and capabilities. More importantly it understands the global and domestic constraints that he is working under. The BOJ recently stopped buying JGB's. In the past this would have been viewed as a normalization signal and the Yen would have strengthened.

The fact that the BOJ chose to end its purchases at a time of chaos in the global economy, with Italy and trade tensions getting the headlines, was a brave form of intuitive probing of market sentiment. The Yen actually weakened, sending the signal that the market understands that the BOJ is technically tinkering with its yield curve targeting policy rather than tightening monetary policy per se.

The market understands that now is not the time for the BOJ to signal the ending of QQE. Governor Kuroda just got his first happy coincidence. His hand and his resolve have been strengthened.

Having worked the foreign exchange markets beautifully, Governor Kuroda then chose the unfolding trade war crisis with America at G7, to send the message that the BOJ is prepared to stay the course and ease again if needed. With his classic loaded understatement he simply noted "some weakness" in the Japanese inflation data. He attributed this weakness to transitory factors and also the framed the current trade war spat as not being significant enough yet to reverse the Japanese recovery. He has however laid down his marker, which he will refer to in the future to explain any change in policy that can be seen as prolonging or expanding the current stimulus.

Following up on Kuroda, Deputy Governor Masazumi Wakatabe concurred that hitting the inflation target remains some way off. In the event of future expansion of monetary policy to hit it, he rules out deliberately weakening the yen through buying US Treasuries.

Whilst there have been some small glimmers of how easier monetary policy may come about in the future, currently the BOJ is adhering to the accepted developed global central bank meme that the normalization of crisis monetary policy easing should be unwound.

Concurrent with this global meme, Deputy Governor Wakatabe framed perceptions of the BOJ's normalization; with the view that it will not sell JGB's but rather will mop up smaller pockets of liquidity.

BOJ adviser and Kuroda ally Masahiro Kawai mapped out the global meme scenario, whereby the Fed drives interest rates higher; thus strengthening the US Dollar against the Yen so that the BOJ is prompted to follow suit with tighter monetary policy. This rosy scenario, akin to the Goldilocks scenario being opined by New York Fed President John Williams, has a strong element of wishful thinking and self-fulfilling propaganda behind it. The BOJ, would love to give those entrenched disinflation thinkers a huge nudge to dislodge their bias. A weakening of the Yen driven by the Fed could serve as said external nudge.

Hitching the BOJ's wagon to the Fed's would certainly help, since the US economy seems to be the only developed economy with any momentum at present. Rising US interest rates are generally viewed as a headwind for America's trade partners. Kawai is thinking and opining out of the box, to see if there is any positive halo effect from this headwind that he can leverage off.

(Source: Nikkei Asian Review)

The BOJ positioned its upcoming monetary policy meeting, that coincides with the Fed (and the ECB's) meetings to the same effect, by leaking that it will hold a thorough debate over why inflation is decelerating. It was also suggested that the inflation forecast will be officially lowered. From this point, the pivot towards extending and even expanding QQE is a small step. There is also flexibility to react towards the market moving news out of the Fed and the ECB.

It should be noted that earlier in this report it was suggested that the progress towards further monetary policy easing has been made conditional upon an official change in the inflation forecast. This new leak suggests that this box is just about to get ticked.

The remarks made by former BOJ operative Kazuo Momma above, about the next step in the attempt to expunge deflation psychology, should also be carefully noted. Should the leak about lowering the inflation forecast be proven to be correct, then Momma's box will also have been ticked.

The BOJ is not only adopting a wait and see approach, to the Fed's convergence on the neutral rate and the ECB's signal about the end of QE. It is also probing for a way to positively leverage over these two events.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.