What Everyone Will Ask Kuroda Today: Why Has The BOJ Has Already Tapered QE By 45%?
Unlike Wednesday’s FOMC decision, few are excited about tonight’s BOJ announcement in which Kuroda is expected to announce no changes; in fact the biggest mystery is what time the “fluid” meeting will take place. What little suspense there is in Kuroda’s remarks, will likely be confined to his comments during the press conference about the BOJ’s exit strategy.
For those who plan to stay up in hope of catching some of the USDJPY volatility upon the BOJ announcement, here is a recap of what to expect from BofA:
We expect the Bank of Japan to remain on hold at its 16 June monetary policy meeting (MPM), keeping both its targets for rates and risk asset purchases unchanged. We also think the policy board will retain the “about ¥80tn” guideline for JGB purchases and refrain from announcing official tapering out of concern that doing so may send an unintentionally hawkish message to the markets. The central bank has every reason to be cautious. Growth has been running well above potential in 1H17, but price pressures remain weak, with BoJ-style core inflation (CPI ex fresh food and energy) languishing at 0.0% as of April. Downside risks to the inflation outlook suggest the BoJ is nowhere close to hiking rates or shrinking its balance sheet.
However, with the media and some members of parliament expressing increased interest in the BoJ’s “exit strategy”, we believe it will be a focal topic at Governor Kuroda’s post-MPM press conference. But we doubt he will say anything new. The governor will likely remain cautious in his communications, reiterating that the central bank is not yet considering specific plans, given the 2% inflation target remains a long way away.
The Sankei Shimbun recently reported that the BoJ board will consider upgrading its overall assessment of the economy at the 20 July MPM, when it updates its estimate of the output gap in the next quarterly Outlook Report. However, risks to the board’s FY17 Japan-style core inflation forecast of 1.4%YoY are tilted firmly to the downside, in our view, especially if commodity prices stay at current levels. Another downgrade to the board’s CPI forecasts seems likely in July, or by the October MPM at the latest. In our view, the last thing the BoJ wants to do in this situation is to signal policy tightening.
In the absence of policy changes, the focus will be on Governor Kuroda’s post-MPM press conference, scheduled for 3:30pm JST. We expect the Q&A to be dominated by two themes: (1) the BoJ’s latest stance on an exit strategy from ultra-accommodative monetary policy and (2) the seeming contradiction between the policy board’s commitment to increase its JGB holdings at an annual rate of “about ¥80tn” and the ongoing slowdown in the central bank’s bond purchases, which we now estimate is running at about ¥60tn.
But before we get into BofA’s discussion of these two topics, it is worth reminding readers of something we first noted three months ago: the BOJ is quietly engaging in stealth tapering of its QE, for the same reason that the ECB will have no choice but to taper its own purchases – it is running out of eligible bonds to buy.
In a report by JPM, the bank calculates that in May, the Bank of Japan bought just Yen7.89 trillion ($71.6 billion) worth of Japanese government bonds. This was the the least outright buying since October 2014, when the central bank surprised markets by saying it would increase its asset purchases. Since launching its own version of QQE (before it twisted into Yield Control), the central bank has kept in place its target of increasing bond holdings each year by “about” Yen80 trillion. However, at the current rate of buying, the WSJ writes, the holdings are set to rise this year by only about Yen55 trillion.
The central bank is “technically tapering,” said Hiroshi Shiraishi, senior economist at BNP Paribas in Tokyo. This can be clearly seen in the following chart from Bank of America.
Aside from the a declining supply of bonds held by the private sector, one tactical reason why the BOJ may be buying fewer bonds is its “yield curve control” policy, which aims to keep the yield on 10-year government bonds at zero. This implies it can buy fewer bonds when the yield is close to that target. Wednesday, the yield was at 0.06%.
Previously, Kuroda has acknowledged this slowdown, but has been quick to declare that what effectively amounts to a 35% taper doesn’t signal a retreat from easy-money policies. “At this stage, we are not exiting,” Kuroda said at The Wall Street Journal’s CEO Council meeting in Tokyo on May 16.
Yes but what happens when the BOJ officially announces the need to start tapering? And more importantly, what will be the reaction of the market, which has so far taken the “technical tapering” in stride, in the country where the central bank already owns over 43% of all Japanese government bonds, and where the BOJ’s balance sheet is 90% of GDP?
So, here is Bank of America again explaining what Kuroda will likely respond if and when asked about (1) the BoJ’s latest stance on an exit strategy from ultra-accommodative monetary policy and (2) the seeming contradiction between the policy board’s commitment to increase its JGB holdings at an annual rate of “about ¥80tn” and the ongoing slowdown in the central bank’s bond purchases, which we now estimate is running at about ¥60tn.
We think Governor Kuroda’s communications will remain cautious in response to both issues. Attention on the BoJ’s exit strategy has increased since Bloomberg reported in an 8 June article that the BoJ was considering “re-calibrating its communications to acknowledge that it is thinking about how to handle a future exit from monetary stimulus, without giving the impression that this is on the agenda anytime soon.” At the same time, opposition lawmakers have raised greater concerns over the BoJ’s financial health when the central bank eventually raises interest rates and have pressed the central bank to disclose detailed exit plans and its associated costs. While the Bloomberg article did not contain any new information, in our opinion, it ended up causing some volatility in the markets, suggesting investors will remain sensitive to Governor Kuroda’s comments. For this reason, we think the governor will likely say very little on the subject.
On slowing JGB purchases, Governor Kuroda is likely to acknowledge-as he has in recent Diet hearings-that the rate of increase in the central bank’s JGB holdings has recently fallen to around ¥60tn on an annualized basis. However, we expect the governor to stress that the slowdown in JGB purchases does not reflect intentional “tapering” but reflects an automatic adjustment mechanism under yield curve control (YCC). In other words, the slowdown in BoJ bond buying is a result of reduced upward pressure on JGB yields, reflecting a fall in US rates.
In other words, Kuroda will hope that the BOJ’s communication remains on autopilot. Still, at a time when the Fed just laid out what its balance sheet normalization would look like, and when even the ECB has “trial ballooned” it will soon follow, the discussion will inevitably turn to the most sensitive topic facing not only the BOJ, but Japan itself: how does the central bank hope to reduce its gargantuan balance sheet, which recently surpassed that of the Fed. Here is BofA’s answer:
The BoJ has continued purchasing significant amounts of JGBs for over four years under its QQE policy, and consequently its balance sheet has ballooned to over ¥500tn, comparable in size to Japan’s GDP. Various side effects have emerged. Since the beginning of 2016, the BoJ has carried out more JGB lending through Securities Lending Facility operations, a sign that the market shortage of JGBs has become more serious. Moreover, the repo rate plunged near the end of FY16 (March 2017) due to strong demand for TBs. Recently, the BoJ has reduced its purchases of short- and medium-term JGBs, so its Securities Lending Facility operations have also dwindled. The rise of short- and medium-term yields shows supply-demand has eased somewhat. However, if investor demand (and not necessarily such strong demand) turns to JGBs again, the risk is rising that supply-demand will tighten and prices will be distorted.
Naturally the BoJ knows this very well, so last year it introduced yield curve control (YCC) as a step on the way to making monetary policy more sustainable. So far the BoJ has succeeded at maintaining yields near targeted levels, and it has quite smoothly reduced its JGB purchases. The year-on-year increase in the BoJ’s holdings of JGBs has declined to about ¥70tn, well below the guideline figure of ¥80tn. If the current purchasing pace is maintained, YoY growth in holdings will decline even more. The BoJ’s gross annual purchases amount to about ¥96tn now, and at the end of May it held ¥43tn of JGBs that were set to be redeemed within one year, so its net purchasing pace is around ¥53tn now. For five months from January to May 2017, the BoJ increased its JGB holdings by ¥30tn, and if the current purchasing pace is maintained, its JGB holdings should increase by about ¥60tn in 2017.
Whatever explanation Kuroda comes up with, the reality is that the “liquidity impulse” generated from purchasing ¥53tn vs the designated ¥80tn, represents a greater than 30% reduction. And sooner or later, the market will realize that the liquidity added to the market by the BOJ is nearly half of what it should be in theory. That moment could result in a rude awakening, as it will likely come as the Fed continues to tighten its own monetary policy with the ECB potentially starting to tighten too as it is about to run out of eligible Bunds to buy. So how will the BOJ proceed? Here, again, is BofA:
We think the BoJ will find it difficult to change policy for the time being, so the JGB market’s volatility might stay low for a while. However, as the economic recovery deepens and domestic inflation picks up, it would not be surprising to us if the BoJ increased its communications with the market and put more effort into forming a consensus about its exit from QQE. Of course, it will proceed cautiously to avoid sudden yield surges and yen appreciation. If some conditions are fulfilled-inflation rises to about 1% and the Fed and ECB proceed steadily towards monetary normalization-it is possible the BoJ shifts from excessive easing to a more sustainable monetary policy even if its exit lies well in the future (The BoJ’s public and private face). One risk is that an unexpected event triggers global risk avoidance leading to lower yields and a simultaneous round of yen appreciation. For example, even if the 10yr yield fell far below its target, a reduction in JGB purchases could prompt further strengthening of the yen. Steering this course would not be easy. In that case, the BoJ would probably need to take countermeasures such as setting a minimum yield and continuing with its purchase operations.
Finally, here is Bank of America’s take on what the BOJ’s action could mean for the Yen:
The BoJ is widely expected to leave its policy unchanged, and the Fed’s stance and US data will be the predominant concern for the USD/JPY. We believe the BoJ is careful about not sending the wrong signal about a policy exit when the financial market is questioning the strength of the US and Chinese economies, and Japanese inflation measures are hovering around 0%. Instead, the market is likely to focus on upcoming US data to judge if the Fed is right about its policy normalization plan, forcing the market to catch up, or the Fed has to adjust toward the dovish market expectation.
We argued that self-sustained USD strength may need more time to materialize such that Japanese equities may be a better position for now. In fact, our US strategists argue it could take a few more months to know whether the US will reform its tax system. We prefer being long NZD/JPY for now while we fundamentally remain constructive on USD/JPY.
In short, for now the BOJ remains on autopilot, which is why don’t expect much from today’s BOJ announcement.