The Bank of Japan starts a two-day meeting Thursday. Given the massive fiscal stimulus in the pipeline, no change in the major monetary policy settings is expected. However, the policy review may result in some cosmetic changes that are likely to have very little market significance.
As we noted in our recent FOMC and BOE previews, curve steepening is a global phenomenon. The US and Australia are leading the pack due to their relatively strong economic performances. However, several major economies are not seeing the same degree of steepening such as Germany and Japan, as their economies have underperformed on a relative basis. Therefore, they may also be the most vulnerable to tightening financial conditions if curves continue to steepen worldwide. The UK is somewhere in between these two groups
POSSIBLE NEXT STEPS
At the December 17-18 meeting, the Bank of Japan unexpectedly announced a policy review. It extended its emergency lending and liquidity programs for six months then whilst keeping rates and asset purchases unchanged. However, it pledged to review the sustainability of its policy framework. The bank stressed that there was no need to scrap its yield curve control as part of the review, but the announcement suggests there will be tweaks coming that will seek underscore its commitment to maintain its accommodative stance for even longer. Governor Kuroda said then that “Our intent is to keep short and long term policy interest rates at their present or lower levels, and we won’t be reviewing negative interest rates.” What can we expect Friday?
1. Tweak ETF purchases – VERY LIKELY NOW, VERY LIKELY LATER in 2021. Reports suggest the BOJ may scrap its annual ETF purchase target of JPY6 trln whilst keeping its JPY12 trln ceiling in place. With the Nikkei 225 now trading at the highest level since 1990, the need for equity market support is clearly hard to justify. The BOJ first started its ETF purchases back in October 2010 as part of its so-called Comprehensive Monetary Easing (see “A Brief History Lesson” below). Then, the Nikkei 225 was trading below 10,000. Now trading around 30,000, equity markets simply do not need any further BOJ support and so it makes sense to remove its annual target and allow the bank to act with more flexibility.
2. Jawbone the yen weaker – POSSIBLE NOW, LIKELY LATER IN 2021. The BOJ is well aware that it’s always easier to move with the FX market than against it. While FX intervention has become very rare for the BOJ, it is not shy about verbal intervention and so it may take this opportunity to extoll the benefits of a weaker yen.
3. Jawbone yields lower – POSSIBLE NOW, LIKELY LATER IN 2021. Governor Kuroda recently stressed the need to keep the entire JGB curve low and stable. One potential side effect of rising JGB yields would be a firmer yen and that is something that policymakers would like to avoid.
4. Tweak macro forecasts – UNLIKELY NOW, VERY LIKELY IN APRIL. The BOJ just updated its forecasts in its Outlook Report for the January 20-21 meeting. The bank upgraded the growth outlook for FY2021 to 3.9% from 3.6% in October and for FY2022 to 1.8% from 1.6%. Inflation for FY2021 is seen a tick higher at 0.5% and steady at 0.7% for FY2022. These will be updated again at the April 26-27 meeting, when FY23 forecasts will be added. The December forecasts are slightly more optimistic than current market consensus and OECD forecasts and so we think the bank is likely to signal ongoing downside risks to the economy and inflation with some downward adjustments at that meeting.
5. Tweak Yield Curve Control (YCC) –UNLIKELY NOW, POSSIBLE LATER IN 2021. Some officials reportedly want to generate more fluctuation in yields while sticking with the current YCC range of +/- 20 bp around the 0% target for 10-year yields. We are still skeptical that they'd do this in a rising rate environment. At the margin, rising JGB yields would tend to boost the yen. That is why we are skeptical that the BOJ would widen its YCC range in a rising rate environment. Policymakers had already seen the market push USD/JPY to the highest since last June. Why would they rock the boat? Once the recovery is on sounder footing, it’s possible that we could see a wider trading range under YCC.
6. Cut rates - VERY UNLIKELY AT ANY TIME. Reports suggest the BOJ is studying the potential impact of deeper negative rates. Officials may release the report, which would assess the impact on commercial banks and possible measures to help offset the side effects of further cuts. Reports suggest that officials want to shift market expectations for a possible cut but don’t actually plan to go more negative for the time being. Sound familiar? Recall that the BOE helped keep the UK yield curve depressed for much of last year with ongoing talk and study of negative rates. However, the BOE ended the charade at its the December meeting, when it said it was appropriate for markets to prepare for negative rates but said it did not intend to signal that negative rates are coming. The market immediately priced out negative rates and gilt yields bottomed in early January, after which the 10-year gilt yield surged from 15 bp to around 80 bp currently. Hopefully, the BOJ learned something from the BOE.
The yen has a split record on BOJ decision days. Of the ten since last year began, the yen gained against the dollar on six of them. In 2019 , the yen gained against the dollar on three of eight decision days.
We remains bullish on the dollar as we move closer to Q2. Our near-term USD/JPY target is the June 5 high near 109.85. After that is the high from last March near 111.70 and then the high from last February near 112.25. If the dollar can continue its winning streak, then the October 2018 high near 114.55 is likely to eventually come into play. To us, yen weakness/dollar strength is a win-win for both economies. The stronger dollar would tend to dampen price pressures here in the US but help to boost inflation in Japan whilst making their exports more competitive.
Yen positioning is not as overextended as it’s been in the past. The latest CFTC data shows net yen longs for non-commercial accounts stand at 6.5k contracts for the week ended March 9, the lowest since last March and well below the recent high of 50.5k from mid-January. That said, net longs are relatively high compared to early 2020, when the market was net short yen to the tune of -56.4k contracts. As a result, we believe further yen weakness won’t be too difficult to achieve from a positioning standpoint.
A BRIEF HISTORY LESSON
The BOJ first started its ETF purchases back in October 2010 as part of its so-called Comprehensive Monetary Easing (CME). It started out with a ceiling of JPY450 bln, which was doubled to JPY900 bln in March 2011. The ceiling was raised again in August 2011 to JPY1.4 trln, then in April 2012 to JPY1.6 trln, then again in October 2012 to JPY2.1 trln. At his very first BOJ policy meeting in April 2013, Governor Kuroda announced Quantitative and Qualitative Monetary Easing (QQE). Among other things, QQE eliminated the ceiling and introduced an annual ETF purchase target of JPY1 trln. This target was tripled to JPY3 trln in October 2014 and then doubled again to JPY6 trln in July 2016. In March 2020, the BOJ increased its ETF purchases in response to the pandemic with an annual ceiling of JPY12 trln. And that is where we stand now.