- Real rates rise as nominal yields climb while inflation lags
- Currency has gained after each of past five BOJ decisions
The more Haruhiko Kuroda does, the more convinced traders become that the yen’s appreciation is out of his control.
The Bank of Japan’s Wednesday decision marked the fifth straight meeting that saw the yen gain by the end of the trading day. Governor Kuroda and his board shifted the focus of stimulus from expanding the money supply to controlling interest rates, pledging to pin benchmark 10-year yields around zero. While the bank strengthened its forward guidance by committing to an “overshoot” of consumer-price gains, it refrained from moving deeper into negative interest-rate territory.
The yen slipped as much as 1.1 percent to a one-week low of 102.79 per dollar soon after the BOJ’s decision, only to recover all those losses to end the day higher. The Japanese currency has surged 20 percent this year, the best performer among 10 major developed peers, set for its biggest annual advance since 2008.
“Making its policy menu more complex only led markets to believe the BOJ faces limits,” said Daisuke Karakama, Mizuho Bank Ltd.’s chief market economist in Tokyo. “It’s also not clear how much of the difference there is between the BOJ’s previous price commitment and the one aiming at overshooting. Markets weren’t impressed and concluded it’s a yen buy signal.”
Japan’s currency rose 0.1 percent to 100.23 per dollar as of 6:41 a.m. London time on Thursday and touched 100.10, the strongest this month.
There’s an 84 percent chance the yen climbs to a three-year high of 99 by year-end, up from a 59 percent chance seen at the start of September, according to data compiled by Bloomberg using options pricing.
The central bank adopted a more flexible approach to the core of its framework, saying it would adjust the volume of its asset purchases as necessary in the short term to control bond yields, while keeping it at about 80 trillion yen ($797 billion) annually over the long term. The BOJ at the same time scrapped a target for the average maturity of its holdings of government bonds.
Strategists also questioned whether the BOJ can control the so-called yield curve as it envisions. The bank announced Wednesday that, for the rest of September, it will continue to carry out the existing debt purchase operations, where it buys a set amount of bonds at yields determined through competitive bidding. It will also carry out operations “as needed” to buy potentially unlimited amounts of bonds at yields set by the BOJ.
Mari Iwashita, chief market economist in Tokyo at SMBC Friend Securities Co., said the detailed nature of market operations regarding the yield curve suggested the BOJ will likely avoid deep cuts to the negative deposit rate until the new operations take root.
Kuroda already faced skepticism that the yield-curve strategy is a smoke screen for paring bond purchases. He told reporters in Tokyo Wednesday that the new framework didn’t amount to tapering money expansion, and noted that the bank will stick with a bond-purchase target of 80 trillion yen ($788 billion) a year for now. Still, he didn’t rule out the chance of a slower pace in the future.
While the BOJ may be able to contain yields from an overshoot and guide them towards zero for 10-year notes using the new operations, it is unclear how the bank can cope if yields drop to lower levels than those policy makers deem appropriate, said Katsutoshi Inadome, a senior bond strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo.
“The BOJ has only two options -- sell long-term government bonds or forgo buying operations -- when doubts about inflation and the economy raise speculation about more BOJ stimulus and push down yields,” Inadome wrote in a report after the BOJ’s decision. “If the first option is unrealistic, it seems difficult to lift yields just using the second option.”
Low on Ammunition?
While Governor Kuroda denied any intention of scaling back the amount of bonds the BOJ buys, or tapering, the currency market’s reaction shows traders saw it as a tightening step rather than an easing one, Mizuho’s Karakama said.
“Whether it’s tapering or not, aiming to peg 10-year yields around zero means a reduction in bond purchases will become inevitable,” Karakama said. “Many market players associated more bond buying with a weaker yen, so scrapping that would naturally mean for them a yen buying factor.”
After 3 1/2 years of massive bond purchases gave the BOJ more than a third of the world’s second-largest bond market, Kuroda was facing concerns about the sustainability of those purchases, which have run at about 15 percent of gross domestic product annually. And the decision to overhaul policy again -- for the third time under Kuroda alone -- underscores the challenges he faces. A benchmark gauge of Japan’s consumer prices slumped 0.5 percent in July from a year before, far from the 2 percent gains targeted “at the earliest possible time.” GDP has fluctuated between rises and falls in recent quarters.
Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co. in Tokyo, and a former central bank official, also expressed doubts about the BOJ’s ability to control the yield curve, especially if longer-dated yields face pressure to decline. Selling Japanese government bonds could risk the bank going beyond tapering and straight to reducing quantitative easing, he said.
“If the BOJ is aiming to raise nominal rates while not succeeding in fueling inflation expectations, real interest rates will rise,” Sasaki said “The BOJ is actually pushing real interest rates higher which point to the yen’s strengthening.”