Pressure on BOJ to pivot recedes while Japan’s political establishment faces big shakeout

The yen’s most recent snap-back seem to have Japan equity analysts, especially those covering multinationals and exporters, hurrying back to their earnings models to adjust their estimated forex benefits in their forecasts for next term.  As we have long forewarned, Japanese manufacturing stocks, namely shares of auto-related and semiconductor equipment makers which have strongly led the market higher in the first half of this year now look highly vulnerable to a derating due to their own idiosyncratic issues that a stronger yen could only worsen. 

However, as we have also noted the recent rebound in the yen against all major currencies should have removed much pressure on BOJ to act soon by abandoning its ultra-loose monetary policy. Moreover, beyond abandoning its Yield Curve Control that would send a clearer message of a policy pivot, further tweaks will have no real meaningful impact at this stage. 

With the benchmark 10yr JGB yield also well below 1%, the pressure from the bond market on the central bank has also eased as falling inflationary expectations in the US have generally led to better functioning bond market recently. Indeed, BOJ has recently lowered its JGB purchases under its QE program that underlines that. So we are not too hopeful that we will see BOJ making any dramatic moves before the year-end, away from its zero rate policy.

In the meantime, Japan is going through what looks to be a major political upheaval that looks likely to  shake the foundation of the ruling LDP party and its key factions looking entangled in alleged undeclared donations and slush funds. This will surely now topple Japan’s prime minister, Kishida-san who we continue to think will likely be replaced by next April.

We only hope that this will give popular reformists within the party, namely Taro Kono an opportunity to be chosen as party leader and help clean up the political group’s increasingly tarnished image not unlike what Koizumi-san did in over two decades ago. We think such an outcome should be received very positively by the market.

Indeed, we welcome any change that would avert this fiscal disaster unfolding in Japan with big government spending plans and no plans to finance it through taxation for another two years. Although the market is clearly not currently focused on the likely surge of JGB issuance needed to refinance the existing debt which is now a quarter of the national budget, we think the rising issuance of debt at probably higher rates would put much upward pressure on Japan’s bond yields over the next few years.