Last week we wrote an article in which we explained “How The Bank Of Japan May Be About To Unleash A Global Selloff.” While some may argue if what we have seen in the past few days is a global selloff or just a significant repricing of risk, one thing is clear: as Kuroda plans his next step, he has certainly unleashed nothing short of global chaos.
Before we get into the specifics, consider the following apt summary courtesy of RBC’s Charlie McElligott, who writes the following in his morning wrap:
“The BoJ “trial balloon” media-blast is being cranked-up to ‘11’ in the past 24 hours, with headlines in both Nikkei and Reuters have touted their desire to go even more negative on rates (as stated in the “RBC Big Picture” first) and now this morning, we get headlines that PM Abe adviser Nakahara is calling for BoJ purchases of 10T yen-worth of foreign bonds in an effort to weaken the Yen (despite Abe saying just last week that such purchases are illegal under Bank of Japan law if they are meant as a form of currency intervention). Funny convo with a customer—basically stating that even if we have the press release listing exactly what the BoJ was going to do, the market response to various policy mixes is such a coin-flip that it’s nearly impossible to prognosticate.”
Confused? You should be, but perhaps not as much as the BOJ itself, which days after leaking intentions to implement a “reverse operation twist” as first explained here, is realizing this may not be the most optimal route.
Consider first what Reuters wrote overnight in “BOJ to make negative rates centerpiece of future easing“, call it “trial balloon #1“, in which it reports that “the Bank of Japan will consider making negative interest rates the centerpiece of future monetary easing by shifting its prime policy target to interest rates from base money at its review next week.”
The change would underscore growing concerns in the central bank and financial markets over the limits to the BOJ’s economic stimulus efforts, as more than three years of aggressive bond buying is draining market liquidity. It would also be a shift away from the BOJ’s unique monetary experiment that attempted to crush yields across the curve and try to convince the public that its massive money printing will boost economic activity and prices.
“Among the BOJ’s policy tools, the priority will likely shift more towards interest rates and away from huge bond purchases,” said one of the sources on condition of anonymity. The Nikkei reported earlier on Wednesday that the BOJ will put more emphasis on negative rates as a tool for future easing.
The BOJ is unlikely to abandon its current base money target, which is the amount of money it commits to print each year, or adopt an explicit cap on long-term rates, they said.
Still, by shifting its policy focus to negative rates, the BOJ hopes to dispel growing market views that the unpopularity of negative rates among the public would discourage it to cut rates, even if it would arrest unwelcome rises in the yen.
Ok, fine, go deeper into negative territory. However, one week ahead of the BOJ’s decision, not even this announcement appears to be agreed upon. To wit:
There is no consensus in the BOJ yet on whether to deepen negative rates at the Sept. 20-21 meeting, when it conducts the comprehensive assessment of its policies, the sources said. That decision will depend on yen moves and whether the board members feel that doing so would be necessary to reinforce the bank’s commitment to achieving its inflation target, they said.
Unwilling to settle just for more NIRP, the BOJ may – or may not – do more: “Most BOJ board members prefer such a modest fine-tuning of the current policy framework. But with markets increasingly expecting some form of easing at the review, more radical options are not off the table, such as ditching setting an explicit cap on bond yields, they said.”
Meanwhile, fears that the BOJ will pursue an unmitigated curve steepening, even with lower negative rates, caused the stocks of Japanese banks to tumble overnight even as pension companies jumped, on a deja vu flashback to what happened in January when the BOJ first shocked the world by unveiling -0.1% NIRP:
[The BOJ is] equally wary of entirely abandoning the base money target, the bank’s prime policy target, for fear of triggering market fears it will taper its asset buying. Policymakers got a taste of how markets might react to that this week as investors dumped longer-dated bonds on fears the BOJ will slow the pace of its purchases. The 30-year JGB yield rose to a six-month high while the 20-year JGB yield rose to 0.495 percent, a level last seen in March.
The BOJ will thus maintain the base money target and the pace of asset purchases. But it will consider changing its prime policy target to the 0.1 percent negative rate it now charges for a portion of excess reserves financial institutions park with the bank, the sources said.
For now however, the consensus is that there are three main options for Sept 21:
The BOJ says it has three easing tools: buying more bonds, buying more risky assets and deepening negative rates.
At next week’s review, it will likely signal markets that cutting rates would be the more preferred future option as it directly pushes down short- to medium-term rates that have the biggest impact on corporate borrowing costs. The BOJ will also consider reducing purchases of super-long government bonds to give financial institutions such as insurers and pension funds a better environment for earning returns, the sources said.
In short, with the trial balloon not having generated a plunge in the Yen, the BOJ may just keep doing much more of what it has already done.
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This brings us to “trial balloon #2“, where in a WSJ article we read that according to Nobuyuki Nakahara, an advisor to PM Abe, the Bank of Japan “should stick to a policy that focuses on asset purchases to achieve its 2% inflation target.” Nakahara’s suggestion is to soak up even more of the already illiquid bond market: “the central bank should increase the amount of cash it pumps annually into the banking sector to Yen100 trillion ($970 billion) from Yen80 trillion partly through the purchase of foreign bonds, said Nobuyuki Nakahara in an interview with The Wall Street Journal.”
Despite Abe saying last week that foreign bond purchases are illegal, “the former central banker said the BOJ could buy an additional Yen10 trillion per year in government bonds, including 50- and 60-year maturity bonds explicitly issued to finance infrastructure investment. The finance ministry doesn’t currently issue such bonds. The bank could also buy Yen10 trillion yearly in foreign bonds, half of them dollar-denominated and half euro-denominated.”
In case that wasn’t confusing enough, earlier today Kyodo unveiled “Trial Balloon #3“, when the Japanese publication reported that the Bank of Japan is now consdering cutting its negative deposit rate to -0.2% from -0.1% now. It adds that the BOJ will effectively scrap 2-year timeframe for achieving 2% inflation target in its comprehensive review to be held at Sept. 20-21 meeting.
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Alas, with so much information to process, the market revolted, as Reuters follows up in another piece this morning, in which it writes that “the yen recovered from one-week lows against the dollar and euro on Wednesday, as investors doubted that reports the Bank of Japan was considering further monetary easing measures would turn into a source of significant weakness for the yen.”
It appears all those BOJ proposed actions tend to mutually nullify each other. As Reuters adds, “sources familiar with the BOJ’s thinking said the central bank would consider making negative interest rates the centerpiece of future easing by shifting its prime policy target to interest rates from base money. But when the BOJ shocked markets in January by cutting rates below zero for the first time in an attempt to weaken the currency, the yen reaction was only temporarily – and since then it has gained almost 20 percent.
“We do expect them (the BOJ) to tweak policy next week, so we do look for a small deposit rate cut and maybe some further support for bank lending – some technical tweaks – but ultimately, is that going to be enough to sustainably weaken the yen?” said HSBC currency strategist Dominic Bunning, in London. “We would argue no. The big bazookas have been used and then yen already looks in slightly undervalued territory so it’s very hard to generate this significant yen weakness
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Finally, throwing everyone into one last loop, overnight Goldman came out with a note saying that the BOJ would do… nothing.
In a note by Goldman analysts, they said that the BOJ may try to incorporate some flexibility in its purchases of super-long JGBs, particularly the 25+ year sector, and provide guidance toward rate cuts later in the year as a means of lowering front-end rates, however it said not to expect the central bank to set in motion a bear- steepening selloff across the JGB curve. It adds that “with a low and uncertain path for CPI expectations, any increase in nominal yields will translate into a jump in real rates that would be counter-productive.”
Goldman also writes that “an increase in real rates could put JPY under an increasing appreciation pressure” and warns that “risk of mis-communication or mis-interpretation of any shifts in JGB purchases would increase market expectations of an impending tapering and could impair the central bank’s pursuit of its price-stability target.”
In other words, the BOJ could well continue to stoke the ongoing global risk asset selloff. As a result, Goldman says to expect BOJ to maintain its monetary-base target and current interest-rate policy, and that Kuroda’s ability to “coherently and comprehensively communicate the results of this assessment, as well as the direction of future policy”, will be crucial in ensuring that BOJ’s commitment toward its price-stability target isn’t lost in translation. For the world’s most perturbed central banker, that may be a tall order.
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Confused yet? One person who is, is Abe’s advisor Nakahara, who told the WSJ that “the BOJ’s policy has become a ‘cloudy cocktail’- nontransparent and difficult to understand.”
The market – if only for the time being – agrees wholeheartedly.