BoJ reboot or tweak? - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that the new BoJ policy approach appears to be a significant shift in policy to try something new that might be more effective (targeting yields along the curve), but appears half-hearted by continuing to stick with most of its previous approach (targeting quantity of asset purchases and money-base expansion). 

Key Quotes

“Its target yield levels (short-term cash rate unchanged at -0.10% and 10-year yield “more or less at the current level (around zero percent)”) generate a still very flat yield curve (rising 1bp per year).

By still forecasting an unchanged pace of asset purchase and money base expansion around 80tn JPY per year (even though providing themselves flexibility on this amount and removing its 7 to 12 year duration target), the BoJ is still likely to place some broad flattening pressure on the yield curve. 

The BoJ is targeting both the yield curve and quantity of purchases.  It would be better to do one or the other not both. We think that moving to yield targeting is a positive development that could significantly reboot BoJ policy.  But the yields chosen are too low for long-term bonds and too high for short-term rates, and the targeted curve too flat, in our view.

The BoJ has also confused the message by retaining a quantitative target, creating doubt that it has confidence in either approach (yield control or money base control).  It is evident that the BoJ itself is divided on the best way forward and Governor Kuroda and the board has compromised on a middle path.  The market was already skeptical that the BoJ had run out of ideas and scope to ease policy; its policy decision this week has not been decisive enough to shake the skeptical mood dominating sentiment.

The response in the JPY after the policy event reflects this sentiment.  It sold off initially as the market saw promise in the shift to yield control, but swung back to the previous strong JPY trend when the changes lacked punch.

The new approach of the BoJ is designed to make it more sustainable and provide a sense of guidance that it will be in place until inflation overshoots its target.  By shifting to yield control, the policy may be more sustainable by allowing the BoJ to buy less bonds and use other methods to control yields, including long term loans, if it runs into constraints over the supply of bonds.

Many in the market had become worried that the BoJ was causing dysfunction in the bond market and pushing yields so low out the curve that it was crunching profitability in the financial sector.  The BoJ is continuing with its quantity targets, and thus it has not totally alleviated concern that this policy will run into limits on the supply of outstanding bonds.  And its 10-year yield target is still very low (essentially sub-zero), suggesting there is little scope for yields to rise above zero for long-term bonds. As such, the profitability in the financial sector will remain relatively constrained.

However, the BoJ is at least supporting a very modest positive slope in the curve.  To the extent that financial institutions can borrow or short-sell short-term securities at negative rates, and invest-long term, the shape of the curve provides some scope to earn a positive margin.  Banks’ profits will still be constrained by their large base of deposit liabilities (paying zero rates of interest).  The BoJ’s tiered approach to rates policy, setting negative rates on only the marginal tier of bank’s current account balances at the BoJ, does still help significantly lessen the cost to banks from its deposit liabilities.

The positive response in bank share prices (albeit less than a day’s worth of trade to judge by) suggests that the BoJ’s positive curve shape target has helped in improving the outlook for bank profitability.”