The biggest news overnight, and certainly far bigger than this afternoon’s non-event from Janet Yellen, was the significant change in monetary policy announced by the BOJ which (belatedly) unveiled its re-revised “QQE”… this time “with Yield Curve Control” (or “QQEWYCC“), a phrase used in lieu of “Reverse Operation Twist”, whereby the BOJ is hoping to steepen the yield curve and undo the damage it itseld created in January when it introduced NIRP for the first time to Japan, without doing much of anything else.
While we laid out the theoretical big picture elements of QQEWYCC both earlier, and two weeks ago, there is a small problem when one gets into the practical nuances of the proposed monetary experiment: nobody really knows how it will work, not even Goldman Sachs, whose BOJ expert Naohiko Baba admitted that he has no clue how the BOJ will actually execute its vision.
Confirming that the “JGB market has become increasingly distorted”, Baba says that
“it is very unclear at this time exactly how the BOJ intends to “control” the yield curve in the future. Based only on the official statement, we think it is likely it will maintain the yield curve at more or less the current level for the time being. However, the question is how it will control the overall level and shape of the curve when financial and economic conditions change in the future. While the JGB market needs to take time to study the BOJ’s intentions, with interest rate movements lessening, we think the pricing function of interest rates as a mirror reflecting real economic and financial conditions will be increasingly lost.”
Ah yes, the old problem with nationalizing a market – whether it’s bonds or stocks – is that it is no longer, by definition, a market but merely a policy tool which has ceased to delivers any informational value whatsoever.
And before market participants get too gloomy contemplating the existential void of participating in something that no longer exists, Goldman has some theoretical considerations on what the BOJ’s announcement meant, namely that under all that unclear verbiage unveiled last night, the central bank has begun a “stealth taper.” To wit:
The BOJ emphasized that it has four means of easing at its disposal going forward: (1) the negative interest rate (short-term policy interest rate) on policy-rate balances in current accounts, (2) 10-year JGB yields (long-term interest rate), (3) expansion of asset purchases, and (4) expansion of the monetary base. The BOJ will continue to apply a negative rate of 0.1% for (1), while purchasing long-term JGBs so as to maintain long-term interest rates at around zero. We think the BOJ aims to control the yield curve by controlling these two interest rate targets, together with the introduction of new market operations as a backstop when interest rates rise. The BOJ decided to maintain the pace of JGB purchases at around ¥80 tn a year for the time being, but it has effectively abandoned its previous monetary base target.
Governor Kuroda of course denied this, but we think the introduction of yield curve control could be considered as paving the way for future tapering of JGB purchases. We think it is likely that by substantially changing the framework, the BOJ aims to attract the market’s focus to yield curve control and slowly move toward tapering in the background. In addition to the high likelihood that it will become increasingly difficult to maintain its large-volume JGB purchase program for technical reasons, the marginal benefits from expanding JGB purchases have already diminished vs. costs involved, as we have repeatedly mentioned. However, as many market participants forecast the forex rate based on the monetary base ratio between two countries, there is an obvious large risk to reducing purchases. Accordingly, we think the BOJ has judged that it needs to divert the market’s attention as early as possible in advance. As we mention later, our impression is that an exit from unprecedented easing is now much more distant. In our view, the BOJ needed to minimize market shock accompanying a shift in policy targets and also make the easing system longer-lasting and more sustainable.
On this we agree with Goldman for one simple reason: in his erudite “take” of the BOJ’s announcement, Ben Bernanke (who was surely dejected that Kuroda did not take his advice to unleash helicopter money) today blogged that “it was puzzling that the BOJ retained its 80-trillion-yen quantity target for JGB purchases; one of these two targets is redundant. I presume that the BOJ was concerned that dropping the quantity target would lead market participants to infer (incorrectly) that the Bank was scaling back its program of monetary easing.”
The fact that Bernanke said that it was incorrectly perceived that the BOJ is scaling back easing, is all we need to know that the BOJ is doing precisely that and by implication, that Goldman is right. In which case, watch out below, USDJPY, not to mention Nikkei, and therefore Abe approval ratings.