Morgan Stanley Sees BOJ Shift in Easing Methods as Bonds Run Out

  • Kuroda may turn to cap on yields, chief economist Feldman says
  • Japan bond yields seen rising gradually amid economic recovery

The Bank of Japan will be forced to change its stimulus strategy as soon as next autumn as it runs out of government debt to buy from the market, said Robert Feldman, the chief economist in Tokyo for Morgan Stanley MUFG Securities Co.

Governor Haruhiko Kuroda may shift to a cap on yields, using bond purchases as needed, rather than buying notes and other assets to hit a monetary base level, Feldman, a member of the advisory council on government debt management, said in an interview on Nov. 6. He expects the BOJ to reach 2 percent inflation around the end of 2016, the middle of its latest target period. He doesn’t see the need for accelerated easing.

“If there’s an issue, it’s what do they do when they don’t have enough bonds left to buy,” said Feldman, who has worked at the International Monetary Fund and the Federal Reserve Bank of New York. “Some sort of regime change will probably be necessary.”

Feldman is envisaging a change in a regime that has cut yields on notes as long as five years in maturity below zero, driven an almost 60 percent rally in the Topix stock index and weakened the yen by more than 20 percent against the dollar since April 2013. The Japanese government bond yield curve has steepened in the past month with longer-dated yields rising as bets on accelerated easing retreated after Kuroda’s board left policy unchanged on Oct. 30.

Eight of 15 economists in a snap poll immediately following the BOJ decision said they see no further monetary easing. Days earlier, 16 of 36 respondents predicted action at the meeting.

Kuroda said this month he doesn’t see any limits to policy, and the BOJ can keep buying bonds until its price target is reached. He has also said earlier this year that there were “many options” available for more stimulus and that the central bank could get creative in the case of further expansion. The monetary authority currently buys about 90 percent of issuance, and has cornered an unprecedented 28.5 percent of the market.

Investors cautioned about bond market functioning in an inaugural BOJ survey. Morgan Stanley MUFG Securities is one of 22 primary dealers obliged to bid at government auctions.

Yield Cap

“It’s difficult to predict when the BOJ will hit the limit of its bond buying, but liquidity is tight and it will continue to weigh on yields,” said Koya Miyamae, an economist at SMBC Nikko Securities Inc., another primary dealer. “In that eventuality, it’s certainly possible that the BOJ would introduce a cap on yields.”

The central bank’s quantitative and qualitative easing absorbs 80 trillion yen ($649 billion) of JGBs annually, compared with just 3 trillion yen in exchange-traded funds and 90 billion yen of real-estate investment trusts. Feldman doesn’t expect an expansion in purchases of those assets.

“I’m not sure that’s such a good idea, and they don’t think so either,” he said, referring to BOJ policy makers. “Bonds roll off. ETFs don’t. So it would make it harder to exit the policy when you need to.”

Economy Optimism

Feldman remains optimistic that wages in Japan will climb, adding to inflationary pressures, even as Morgan Stanley’s own index of annual wage growth slid to the lowest in almost two years -- an aberration he says is due to a disruptive change in the sample at the start of this year.

Consumer prices gained 1.2 percent in September from a year earlier, when stripped of both energy and fresh food costs. That compares to the slump below zero in recent months of the central bank’s benchmark gauge, which includes energy.

Investors say relying on a rebound in fuel costs to revive inflation is risky and any jump in such expenses would damp consumer confidence. Notes linked to the consumer-price index signal a 0.77 percent average rate of increase in the next decade.

Feldman is sanguine about the recovery even as economists forecast the world’s third-largest economy may have slipped back into recession. Third-quarter gross domestic product shrank by an annualized 0.3 percent, following a 1.2 percent drop in the period ended in June, according to the latest median of economists’ estimates compiled by Bloomberg.

“Unless something really bad happens, there’s no reason to use more monetary stimulus,” Feldman said. “Underlying prices really are improving.”

Track Records

Feldman proved prescient when he predicted at the end of last year that stocks would advance sharply while the yen’s decline would be capped around 125 per dollar. In June, with the Japanese currency around that level, he said further weakness was unlikely. It traded at 123.21 as of 10:48 a.m. in Tokyo Tuesday.

Benchmark 10-year JGBs yielded 0.33 percent, the lowest after Switzerland among bonds globally. The yield sank to a record-low 0.195 percent in January.

Feldman expects yields to rise “gradually” as the economy continues to improve, while stocks advance and the yen drifts lower against the dollar, driven by a widening interest-rate differential as the Federal Reserve lifts borrowing costs.

“This move away from QQE to some sort of new regime is happening because the economy is normalizing,” he said. “That’s more important than the individual policy moves.”

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