As Prime Minister Abe prepares for an unprecedented third term, the BOJ adheres to its supporting role. There have been no recriminations, at least in public, of the BOJ’s failure to hit its inflation target. Since the BOJ is running out of financial assets to buy, it is now looking for the Prime Minister and the commercial banks to create some more for it to monetize in the next economic slowdown. Consequently, the banking sector is being rehabilitated with some tweaks to the yield curve, which the government will then attempt to steepen with a new round of fiscal stimulus.
The last report noted the growing risk from the BOJ’s centrality commitment to hitting its inflation target being tested. This risk was said to be heightened by the BOJ’s process of easing with guidance yet normalizing with its actions. Said actions were noted in the steady decline in JGB purchases by the BOJ. Focus has now switched to the BOJ’s declining ETF purchases. Some see this decline as another normalization signal. Others note that the BOJ has already exhausted 65% of its 2018 ETF buying budget already, therefore, necessitating a decline in purchases going forward by default. The jury is out.
BOJ Governor Kuroda recently added to this controversial subject, when again he opined that interest rates will not rise for “an extended time,” but that the inflation target will be hit before his term ends in 2023.
The unfolding global trade war is now also being taken more seriously, as a headwind that may soon become the main priority for the BOJ. Recently, it was reported that the 32 regional branches of the BOJ have embarked upon an unscheduled crisis survey, specifically evaluating the impact of the trade war. If these studies conclude that the impact has been significant, the BOJ will have to consider what if any monetary policy stimulus to apply.
The BOJ guidance by leak process is also seeking to correct misperceptions of the latest BOJ policy tweaks that have resulted in an incremental rise in long-term interest rates. Said sources are keen to emphasize that, whilst the upper bound of the interest rate corridor has been raised, the floor has also been lowered. The lowering of the floor, implies a cut in interest rates which, has been completely overlooked by the market discounting process.
Such a widening in the corridor of interest rate target levels should, therefore, be viewed as a widening corridor of uncertainty. Such uncertainty could see higher or lower interest rates. The risks are therefore balanced, rather than skewed in favour of higher interest rates as Mr. Market assumes.
The low boundary of this corridor of uncertainty was recently illustrated by BOJ Monetary Policy Board member Goushi Kataoka. He opined that there is no utility or logic in the BOJ’s recent tweaks to its policy; that has created and then attracted yields to this upper boundary limit. His illustration is useful in proving that there is also a probability that monetary policy may be eased again. The BOJ is thus faced with balanced risks, just like any other central bank.
(Source: Seeking Alpha)
The rumor mill has gone into overdrive, as the BOJ seeks to promote this form of “unconventional monetary policy guidance” to good effect. Rumor alleges that the BOJ drafted its last equivocal communique in English first and then translated it back into Yen. Rumor also alleges that this was done so that Mr. Global Market does not buy Yen and sell-off Japanese stocks aggressively to disturb the virtuous risk-on cycle that the BOJ has created with words yet conflicting actions.
Sources close to the BOJ have recently flagged that the debate, over the pain and remedy for said pain, in the banking system from ZIRP/NIRP will become more vociferous at the next Monetary Policy Board meeting. Any support for the banking sector, with higher yield tweaks, may not just be to support them but also to elicit a response from them in the form of credit creation. It should be understood that the BOJ is running out of assets to buy. The banking sector thus needs to start intermediating and credit creating again, in order to stimulate the economy and also to give the BOJ something to buy when the stimulus dies out.
Mr. Koji Fujiwara, the head of the banking lobby group, gave a cautious welcome to the BOJ’s recent tweaking of yields in support of commercial banks. The banks would clearly like more support than the recent tweak and have started to lobby for more by asking for a more comprehensive study of the problems that ZIRP/NIRP has created for them. One can imagine that the banks have a whole list of problems already prepared to submit to said study! Mr. Global Market has thus been prepared for some signal on interest rates in light of this debate.
The last report opined the plight of the Japanese regional banks. This plight is expected to get worse, based on signals from their regulator that the BOJ is not willing to intervene with substantially higher interest rates to support their margins.
(Source: Nikkei Asian Review)
A new threat to the regional banks is now looming from foreign activist shareholders who hold significant positions in this sector. Ironically, this foreign interest was created by equity capital raises as a consequence of the 1990’s collapse of the Japanese banking sector. Today foreign activists are demanding a combination of higher dividends and restructuring, to compensate them for the rising risks that they face. Under pressure, from ZIRP/NIRP and a weak demand for credit, the ability to pay rising dividends is falling. Restructuring must then be offered in lieu of rising dividends.
The BOJ may be happy that the foreign activists are forcing restructuring and possibly consolidation in the regional banking sector. This will allow the foreigners to take the blame for the painful process of restructuring and not the BOJ. A wave of restructuring and consolidation in this sector would allow the BOJ to maintain its ZIRP/NIRP strategy. It would appear that the BOJ would like this consolidating and restructuring phase to occur, in preparation for future unconventional monetary policy expansion. A healthier regional banking sector is one of the prerequisites to enable the further expansion of unconventional monetary policy.
On the fiscal policy side of the Japanese economy, a pro-cyclical stimulus is in the making. This is being promoted under the cover of national security and the need to stand up to China when President Trump is showing signs of reducing his commitment to defend Japan. In future, it may take the cover of protecting the Japanese economy from President Trump himself when he turns the trade spotlight directly onto Japan.
The President was able to shake down the Japanese into buying more American weapons however, so he is currently committed to balance trade imbalances with Japan in the name of American and Japanese collective security. The Japanese “record-breaking” 2019 fiscal stimulus being promoted by Finance Minister Taro Aso resembles what Americans once termed “Guns and Butter.”
Japanese defense spending will also be bolstered by welfare spending, as Japan’s traditional ageing pacifists are bribed to make a new social contract based around more traditional martial terms. A pro-cyclical fiscal stimulus will not imbue the BOJ with any sense of patriotism to ease monetary policy further at this stage; on the contrary, it will inspire the opposite reaction.
In addition to “Guns and Butter,” an extra fiscal budget may also be brought in this year to counteract the damage from the recent earthquake and typhoon. Fiscal slippage is underway again in Japan. When it reaches the levels of inability to pay, as the economy slows, the BOJ will then do the buying again to cap yields.
In addition to the “Guns and Butter” fiscal stimulus, there is also a “Counter-Trade War” fiscal stimulus under consideration, to protect Japanese companies who are at the mercy of President Trump. The Japanese auto-sector is at the top of the list for fiscal and pecuniary support.
In general, Prime Minister Abe’s position on QQE has seen a recent transformation towards acceptance of the normalization of monetary policy. In stark contrast, perhaps deliberately, to President Trump, Abe opined his acceptance that easy monetary policy cannot continue forever. He has also reduced the pressure on the BOJ to hits its 2% inflation target in the near future. Evidently, the Prime Minister feels more secure in his leadership position.
He may also be looking for empathy from the banking sector and the nation’s numerous ageing savers. Whatever his reasoning, he has clearly given the green light for the BOJ to officially normalize. As readers know, the BOJ has been unofficially doing this for some time. The BOJ may thus be closer to a position to mitigate the inevitable rise of the Yen, when the momentum investors have caught up with the facts, by slowing rather than normalizing the current unofficial normalization.
Responding with alacrity, to Prime Minister Abe’s removal of pressure on the BOJ to be more accommodative, the Monetary Policy Board left policy unchanged at its latest meeting. It also reaffirmed its commitment to hit the inflation target through a commitment to maintain a loose monetary policy stance. Governor Kuroda concurred with the Prime Minister’s assessment that there is no point in adhering to easy monetary policy, but only once the inflation target is achieved.
Ostensibly, therefore, the BOJ is still committed to QQE since it has not yet hit the inflation target. On the face of it, the BOJ is not following the global central bank's gradual exit from QE. In practice, however, the BOJ reduced its purchases of twenty five years and longer JGBs in yet another mixed signal of tinkering/normalizing.
Governor Kuroda thus continues to ease with words, whilst he tinkers with the yield curve and bank lending margins. In practice, it is still normalizing by guile rather than stealth. The positive outcome is that the banking sector is being encouraged to engage with an economy that is just about to receive a dose of “Guns and Butter” fiscal spending.
The despairing view of former BOJ Monetary Policy Board member Sayuri Shirai, perhaps best sums up the latest status quo. Commenting after the latest inflation data, which showed some improvement but a much longer way to go to hit target, Shirai handicapped the odds of the end of QQE in her lifetime. She graded QQE a failure, based on the current inflation level versus the size of the BOJ’s balance sheet. In her view:
“Completing the process of tapering out purchases of ETFs and bonds, and eliminating the 10-year yield target may take much longer since the Japanese economy may face an economic slowdown after the 2020 Tokyo Olympic Games.”
If she is correct, the BOJ will not normalize officially before 2020 and may have actually to officially ease further. Just as well Governor Kuroda has been tapering unofficially in that case, as it will at least give him some relative tightening to reverse before he eases again!
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