BOJ’s nuanced tweak likely to unleash forces that run counter to its objectives

We have long argued that BOJ’s ultra loose stance could prove to be a grave policy error as it has not only failed to encourage banks to lend more aggressively given that it has flattened their lending margins but it has created huge anomalies in global capital markets that it will ultimately be forced to abandon. We feel stronger than ever about this and believe BOJ is losing much credibility as we believe its reluctance to raise rates is politically motivated as MOF wants to keep government’s financing costs from spiralling.

The central bank’s latest decision to allow the ten-year JGB yields to trade more flexibly above its 0.5% ceiling left its YCC goal posts intentionally opaque in hope of giving the bank more wriggle room to eventually unwind its unorthodox policies towards a gradual normalisation. However, by stating that the central bank continues to view inflationary forces in Japan as transient, market participants will likely to grow wearier of its stance of keeping long term rates near zero. 

As nuanced as this latest credit tightening may have seemed, we believe it will likely unleash forces that run counter to what the bank probably wanted to achieve in the near term. These were to stabilise the Japanese currency and to allow a more orderly rise in JGB yields. 

BOJ’s failure in better communicating its objectives in the face of rising core inflation in Japan which is now above those in the US will likely continue to force the bank to intervene in the JGB market to keep long term rates suppressed while at the same time leaving the yen on its depreciation trend which may force an intervention in the currency market to try keep import prices under control and stabilise Japan’s purchasing power which has been needlessly diminished.

These conflicting policies could spill over to Japan’s stock market which has more or less ignored these domestic macro issues with the Nikkei continuing to trade near its 30-year highs in hope of rising shareholder returns and more effective corporate governance. Come what may, we think we have entered a time of much higher stock market volatility and retain our long bias in domestic related names, particularly financial stocks which should ultimately benefit from a steepening yield curve.