BOJ: When Doves Cry


The Bank of Japan will lag behind most of the other major central banks in normalizing monetary policy.  However, with the BOJ owning 45% of the outstanding government bonds, the traditional debt crisis which many were worried about no longer seems reasonable. 

The BOJ’s two-day meeting concludes tomorrow.  For all practical purposes, there is no chance of a change in policy.  At last week’s G20 meeting Kuroda made it clear that the aggressive stance is needed for some time.  He was quoted in the papers saying, “There is still a long way to achieve the 2% inflation target, but risks are skewed to the downside.”

 Many observers, looking for any drama whatsoever, have focused on one of the two deputies, who ostensibly could dissent in favor of more easing measures.  During his confirmation hearings, Deputy Governor Wakatabe expressed doubts about the BOJ’s forecast that the 2% core inflation target will be reached around the fiscal year 2019.  He suggested that the BOJ could ramp up their bond buying, which as you will recall, has fallen to around JPY45 trillion annual pace (from JPY80 trillion) as the BOJ complemented the aggressive asset purchase program with a target for the 10-year government bond.

If he dissents like many expect, he will join the new board member Kataoka, who has dissented at every meeting since joining in July last year.  Kataoka has consistently called for more stimulus.   We do not expect him to dissent for two reasons:

First, it is one thing to venture an opinion, but as Deputy, Wakatabe may feel a greater responsibility to support the Governor, in a way that Kataoka does not.

Second, the dissent means little.  It would not impact policy, and it would not add much to the discourse.

At the same time, it is important to note that the remaking of the BOJ’s nine-member board has been completed remade under Abe.  The old fissure line has shifted from the Shirakawa era of less activist monetary policy tradition resisting the more activist and unorthodox thrust under Kuroda to how aggressive should the BOJ be in pursuing its inflation target.

As a candidate, Wakatabe was not bound by the BOJ forecasts.  As both Yellen and Powell have explained, the Fed does not have forecasts like the BOJ or ECB.  The regional Fed Presidents and the each of the governors on the board provide forecasts individually.  The median or average is not the Fed forecast despite how it is frequently used.

The BOJ forecasts that inflation will reach its target around FY19, and this has clear policy implications.  To borrow a phrase, patience and persistence are needed.  No new policy initiatives are required.  It no doubt oversimplifies matters, but to influence policy at the BOJ (and ECB), the forecasts seems key.  In order to spur the BOJ to do more, the inflation forecast would need to change.

For the first time at this week’s meeting, the BOJ will publish forecasts for FY20.  These are important.  If its forecast for is that core inflation (adjusted for the sales tax effective Oct 2019) is at 2% (as is the FY19 forecast), we can deduce the Kuroda’s previous suggestion that exiting the extraordinary policy can begin being discussed in FY19.

Even though the BOJ is unlikely to address the political environment, investors are thinking about it.  Specifically, the Prime Minister is in a swirl of scandals of mostly cronyism and his public approval rating, which is important in Japanese politics, is suffering.  It does not appear that Abe’s higher international presence (e.g., visiting the US, discussions and with South Korea), helped him.  Indeed, Abe was unable to come back from the visit with Trump with any tangible win, and it has quickly been overshadowed by the Trump/Macron bromance.

Post-Abe scenarios are being discussed, though we think it is premature.   He shows a tenacity that will be hard to shake.   Still, some pundits are suggesting that former Defense Minister Ishibara is a potential successor and is running ahead in some polls.   He has strong nationalistic security views, but may not be as well positioned on macroeconomics.   This reinforces our sense that while there may be alternatives to Abe, there does not yet appear an alternative to Abenomics.  We have thought of Abenomics as traditional LDP policy raised to the nth power–easy monetary and fiscal policy, preference for a weaker yen.

The conventional wisdom seems to be that the yen would strengthen on Abe’s departure because he was a force that weakened it.  When the history of our period is written, it probably won’t give much weight to the wishes of policymakers, but focus on the forces of movement.   There are two main characteristics of the yen.  Over time, the yen seems sensitive to interest rate differentials, and it often appears to appreciate when risk appetites fall and in highly volatile periods.

We are reluctant to accept this as the safe-haven as is common because of our understanding of how the yen is used as a funding currency to finance other investments.  When those other investments are sold, such as emerging market bonds, then the funding side of the transaction needs to be unwound (in this case buying back the yen).

That said, we suspect that an underappreciated contributor of the yen’s weakness in the 2013-2014 period was the increased international diversification of the Japanese public and private pension funds.  The subsequent appreciation of the yen seemed to correspond to those funds hedging operations.  Recall that Japan’s current account surplus, unlike Germany’s for example, is driven not by exports but by investment income earned abroad.

In any event,  BOJ Governor Kuroda seems is as committed to the 2% inflation target as Prime Minister Abe.  However, a delay in reaching the inflation target, perhaps due to an economic shock, like the retail sales hike, could impact BOJ policy.  While many express concerns that the Federal Reserve will not be able to raise interest rates sufficiently to avoid having to return to near zero (and resume  QE) in the next downturn.  If the BOJ is not careful, it may find that the business cycle is turning and it had yet to pull back on the monetary throttle.

That seems like a greater risk that a change in the LDP official who is Prime Minister.  The kind of crisis might not take the shape of a debt crisis like so many understandably predicted given debt/GDP ratio of well over 200%.   Most observers and investors do not seem to recognize the consequence of the BOJ’s bond buying.  They have diffused the risk of such a crisis by owning more than 45% of the outstanding JGBs.  The consolidated balance sheet of the Japanese government has vastly improved.

It does not mean that there cannot be a crisis.  Far from it. Rather the contours of a crisis in which the BOJ is still pursuing an aggressive asset purchases program and the economy continues to weaken, and even contract is likely different from the sovereign default scenarios that are often bandied about by investors and economists.

A slowing of the Japanese economy is more of a nowcast than forecast.  Japan reports Q1 GDP on May 15.  The economy may have nearly stagnated in Q1.  After growing at an annualized pace of 1.6% in Q4 17, the risk that the economy slowed to around 0.5% in Q1 18.  Industrial output has fallen in Q1 (March data due tomorrow to confirm) and the Tertiary Industry Activity recorded its worst two months (January and February) since the end of 2015.  In March, Japanese exports, which are only around 15% of GDP, nearly a third the level of Europe, rose by an average of 2% in January and February, the slowest since last 2016.