China Slowdown Stokes Bets Kuroda Will Cushion Impact in Japan

  • Spread between two- and 20-year yields drops to four-month low
  • `Factors outside Japan' make it easier for BOJ to add stimulus

The bond market is preparing for Bank of Japan Governor Haruhiko Kuroda to increase stimulus even as he sticks to his rhetoric that China’s market meltdown won’t wreck his inflation goals.

Investors pushed the gap between two- and 20-year Japanese government bond yields to a four-month low last week, indicating growing speculation that the central bank will boost purchases of so-called super-long bonds. An auction of five-year notes, which some strategists called a litmus test of easing expectations, met the highest demand in six months. An increasing number of economists now predict the BOJ will ramp up stimulus by October, after China’s yuan devaluation triggered a global market selloff.

“The China shock and stock rout have added to risks,” said Naomi Muguruma, senior market economist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “Acting before the economic data force him to act is the Kuroda way. And the fact that he can blame factors outside Japan makes it easier to justify.”

Kuroda said on Aug. 27 that the BOJ can achieve its 2 percent inflation target with current policy settings, even as data show Japan’s consumer prices have stagnated and China’s economic growth remains stuck below the government’s target of about 7 percent this year. A lawmaker who has advised Prime Minister Shinzo Abe said last week the BOJ’s Oct. 30 meeting would be a “good opportunity” to expand stimulus, amid signs that central bank officials’ confidence in underlying economic growth is wavering.

Haruhiko Kuroda
Haruhiko Kuroda
Photographer: Akio Kon/Bloomberg

More than a third of 35 economists surveyed by Bloomberg from Sept. 7-10 predict additional easing by the end of next month, including two who expect action Tuesday. The proportion that sees no expansion of stimulus fell to 37 percent of respondents from 43 percent in the previous poll between July 27-Aug. 3.

Bond Returns

A Bank of America Merrill Lynch index of Japanese government bonds has gained 0.5 percent in the month since China’s currency devaluation on Aug. 11, as more than $8 trillion was wiped from global equities. Japan’s Nikkei 225 Stock Average erased its gains for the year before rallying Sept. 9.

The gap between the two- and 20-year JGB yields narrowed to 108 1/2 basis points at the Tokyo close on Sept. 8, the least since April 30 when the central bank pushed back its forecast for achieving 2 percent inflation to around the April-to-September period of 2016, even as it refrained from expanding stimulus. The spread was 110 basis points as of 6:58 a.m. in London on Monday. Ten-year yields were little changed at 0.36 percent.

At the end of October, the BOJ increased the scale of its quantitative easing to the point where it could buy every new bond that the government issues. Investors have voiced concern that a lack of liquidity is adversely affecting market functioning, with yields on government securities with maturities as long as one year at or below zero.

“A major expansion in government bond purchases would be next to impossible from the standpoint of the sustainability of the program, so an effective strategy would be to reduce buying of short- and medium-term debt in favor of super-long bonds,” said Yusuke Ikawa, a UBS Group AG strategist in Tokyo. “That means if expectations for additional easing increase, it would tend to flatten the yield curve.”

Kuroda reiterated Thursday that he expects inflation to pick up to the bank’s 2 percent goal around the first half of the fiscal year starting in April 2016. He repeated on Aug. 27 at a Japan Society event in New York that the BOJ can achieve its target with the current monetary stimulus, even as it stands ready to adjust policy if needed. He said China will achieve economic growth of 6 percent to 7 percent this year and next, and weakness in Japan’s exports and output would pass. China is Japan’s largest trading partner.

Despite Kuroda’s confidence, central bank officials now say the outlook may not be so clear, making them cautious about the potential for a pickup in inflation, according to people familiar with the discussions.

“The global financial market landscape has changed drastically, casting a shadow over the economy,” JPMorgan Chase & Co. strategists Takafumi Yamawaki and Yuya Yamashita wrote in a note to clients Friday. “Risks of a renewed selloff, of a continued stagnation in markets, and of additional BOJ stimulus all argue for the need to increase super-long bond holdings as a hedge.”

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