At its Monetary Policy Meeting on July 30-31, the BoJ left the short-term policy rate, the target for 10-year yields, and the size of ETF purchases unchanged. However, there are three important rhetoric/policy changes for the market that one should be aware of.
- The BoJ expressed the willingness to accept more volatility in long-term yield movements by stating: "The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices." Later at the press conference, governor Kuroda stated that the Bank would tolerate +/-20bp fluctuation of 10Y yield around 0% target (versus +/-10bp at present). Regarding the possibility of a further widening of the tolerable level of 10Y yield ﬂuctuation, governor Kuroda stated that the latest measure would fully ensure the sustainability of the current easing policy. Governor Kuroda went further and explained at the press conference that the wider range of fluctuation was introduced in order to support the functioning of the market rather than to address any side-effects for ﬁnancial institutions' earnings as some media suggested ahead of the meeting.
- Secondly, the BoJ introduced new forward guidance for policy rates: "The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019". Mr. Kuroda explained that the introduction of forward guidance allows the Bank to fully refute exit speculation within parts of the market.
- Last but not least, the BoJ decided to switch ETF purchases more away from Nikkei-linked products to TOPIX-linked products and provided more flexibility regarding the amount of purchases by stating: "The Bank may increase or decrease the amount of purchases depending upon market conditions". The BoJ will now target an 87% weighting for ETFs that track the TOPIX (previous weighting: 75%) and halve the weighting for ETFs that track Nikkei indices to 12%, from 23%. The BoJ already changed weighting of indices for ETF purchases once before in 2016.
One should also take a deeper look at the governor Kuroda post-meeting press conference statement as he provided more clarity about the most recent BoJ policy decisions. In detail, Mr. Kuroda stated that the BoJ's most recent action is aimed at ensuring the sustainability of the current easing policy. He also stated: "Based on its intensive review of current inﬂation stagnation, which coincided with the latest Outlook Report, the BoJ concluded that its 2% inﬂation target would not be achievable even in FY2019, and thus an extension of existing monetary policy was required."
That said, the new guidance clearly suggests that the next adjustment to the monetary policy framework will take place after the consumption tax hike in October 2019, unless inflationary pressures in the meantime surprise significantly on the upside. Furthermore, the tax hike itself is not important but rather the implications on the real economy which means that meaningful changes of the monetary policy should not be expected before the effects of the consumption tax hike will be visible (at least six months after the imposition).
The latest BoJ rhetoric/policy changes, therefore, imply two important implications for the market in my opinion. First of all, setting the ETF purchases weight close to the market weighting is supportive for Japan's equity market in my opinion as it is better reflection of the market sentiment. The investors are concerned about the corporate governance in Japan but the fact that the central bank is adapting to the market conditions should help improve investor confidence in the Japanese equity.
Secondly, while JPY weakened in the aftermath of the BoJ meeting, appreciation pressures soon re-emerged as 10Y yield surpassed 1.12%. However, the most recent BoJ rhetoric suggests that JPY is set to weaken against both EUR and USD in medium term.
Chart 1 and 2: EUR/JPY and USD/JPY movements before, during and after the BoJ monetary policy meeting:
After all, governor Kuroda clearly stated that the latest measures are fully ensuring the sustainability of the current easing policy. This suggests that the BoJ has no intention to increase the tolerable level of 10Y yield ﬂuctuation in the near term which is not surprising given the several key events that are scheduled through the course of this year and next. Namely, LDP presidential election will take place this September while nationwide local elections are scheduled in spring next year, Upper House elections next July, and a consumption tax hike next October.
Chart 3: Japanese 10Y government bond yield:
All in all, the spread differential between Japan and the eurozone as well as the US is set to narrow marginally in the near term due to the market reactions to the BoJ's most recent announcement to allow 10bp wider fluctuation around the 0% target. However, the BoJ clearly expressed their willingness to keep ultra-loose monetary policy intact through the course of this year and next. At the same time, the latest Fed projections suggest that the Fed will deliver a cumulative of five more rate hikes this year and next, while the ECB will end its QE at the end of this year and will most likely deliver first rate hike in the final quarter of 2019. I, therefore, expect to see higher EUR/JPY and USD/JPY levels in the coming quarters and current levels seem as a good entry point.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in JPY over the next 72 hours.
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.