BOJ’s tweak leaves our year-end message with a few more thoughts

Although the last weekly publication (link above) was meant to be our last for 2022, BOJ’s yield curve control tweak last week was too important not to highlight to conclude our thoughts for the year. This is especially so given the number of weeklies we have dedicated to what we strongly believe has been BOJ governor’s ongoing policy errors which had partly led to the yen being one of the weakest major currencies this year.

As we have argued, with rising inflation rates in Japan likely to remain stickier and wage hikes in the coming spring looking to average 3%, BOJ will be forced to allow long term rates to head higher. To be sure, we thought the BOJ chief, Mr Kuroda could resign before his term ends as he has left no notable off-ramp from his questionable strategy of keeping rates near zero based on the view that Japan inflation which will correct downwards in due course. It also ignores the structural shortage in Japan’s labour market which will force wages higher and meet one of the last preconditions Kuroda has outlined for changing course. 

But with price hikes being pushed downstream, it is clear that inflationary pressures will remain elevated, even if yen’s recent strength will somewhat help contain future price rises. Moreover, Kishida Government’s subsidies to lower household costs will likely prove a temporary respite and at some stage could become economically problematic to discontinue.

Mr Kuroda explained that the latest move to double BOJ’s tolerated 10-year yield ceiling to 0.5% is merely a tweak on improving liquidity in the JGB market. However, he failed to outline the obvious, that poor liquidity is mainly a by-product of his monetary policy mismanagement and his outsized QE. Come what may, we think Kuroda has blinked and market now senses that BOJ’s YCC will need to be eventually dismantled and relatively soon. 

We think liquidity in JGBs will most likely remain a major issue as we suspect BOJ’s 10 year yield ceiling is nowhere near high enough to quell the selling pressure. Moreover, we sense BOJ will now face more determined market players to test its resolve , especially macro funds who now smell blood and see more upside pressure on yields forcing BOJ’s hand.  

We continue to believe that shares of Japan banks and insurance firms are likely to outperform further while the yen looks to regain more lost grounds and reclaim some of its safe haven qualities. We see the dollar/yen rate which looks to have staged a major trend change in November to be trading below 120 level by next summer should JGB yields continue to rise while in the US the Fed slow down its rate hikes. In that scenario, Corporate Japan’s overseas earnings which had been notably flattered by weaker yen will be badly hit from yen’s potentially significant trend reversal, especially in H1 of 2023.

Once again, we like to wish our readers a happy holiday and a good new year.