Markets

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

(Updated )

Federal Reserve Chair nominee Jerome Powell has compared central bank communication to a Far Side cartoon: A man chides his dog, and all the dog hears is "blah, blah, blah."  

It may be time to start paying attention to Bank of Japan Governor Haruhiko Kuroda.

As the world's largest central banks move to tighten next year, the BOJ is looking like the lone dove. So it's no surprise strategists are pouncing on any hint that Japan might tweak its yield-curve control policy and start tapering.

They found one Nov. 13, in a speech the governor made at the University of Zurich. Reading it through, it looks as if Kuroda (should he be reappointed by Prime Minister Shinzo Abe) has every intent of abandoning his fixation with a zero percent 10-year government bond yield. Kuroda said this of the consequences of keeping interest rates too low:

Another issue that has recently gained attention with regard to the impact on the functioning of financial intermediation is the "reversal rate." This refers to the possibility that if the central bank lowers interest rates too far, the banking sector's capital constraint tightens through the decline in net interest margins, impairing financial institutions' intermediation function, so that the effect of monetary easing on the economy reverses and becomes contractionary. 

A BOJ board member, Hitoshi Suzuki, added fuel to the fire by telling a local newspaper a week later that it would be possible for the BOJ to make small changes in its yield-curve control program when Japan's inflation rate approaches 2 percent. Kuroda himself has been saying since October 2016 that Japan is no longer in deflation.

There are plenty of reasons to believe the BOJ will start tapering soon. Japan's banks have barely expanded their loan books, despite the central bank's generosity.

Where's the Loan Growth?
Japan's bank loans have hardly expanded despite the BOJ's easy-money policy
Source: Bloomberg, Bank of Japan

And there's probably no point waiting for that 2 percent inflation goal. It's unclear the BOJ will ever be able to lift its preferred CPI gauge -- excluding food prices -- to that level, as deflationary trends hit economies from the U.S. to China. (Inflation in the Group of Seven countries averages just 1.88 percent, according to the OECD.)

Deflation Everywhere
Can the BOJ achieve its 2 percent inflation target?
Source: Bloomberg
Note: This chart uses Japan's CPI inflation ex-food, China's CPI inflation, and the U.S. Personal Consumption Expenditure Core Price Index.

Meanwhile, Japan's banks may be buffered against the impact of a sudden rise in government bond yields, because they have been reducing their holdings since Kuroda took office in 2013.

Bring It On!
Japanese banks can absorb market losses if the BOJ raises government bond yields
Source: Bloomberg, Bank of Japan

Morgan Stanley now expects the BOJ to raise its target for 10-year note yields to 0.25 percent in the third quarter of 2018, while JPMorgan Chase & Co. sees the central bank reducing bond purchases to 40 trillion yen ($360 billion) next year, from the current 60 trillion yen annual pace.

Plenty of skeptics remain, however. After all, the BOJ would face little pressure to defend its current policies next year if the U.S. yield curve turned "completely flat." According to Katsuhiko Aiba of Citi Research, the BOJ's discussion of possible negative side effects of its yield-curve policies was intended to prepare investors for a new "long-drawn-out battle."

Kuroda's "reversal rate" remark caused a stir in Japan. Speaking in parliament on Tuesday, the governor said this theory was useful but didn't apply to Japan's current situation. He acknowledged, however, that the BOJ's balance sheet is much larger than those of the Fed and the European Central Bank, and said the bank will consider how to handle this.

If the BOJ does start tapering, the market implications will be far-reaching. Export-oriented Japan Inc. has had its best earnings in years, thanks to a weaker yen. That advantage could evaporate quickly with a stronger currency, while the nation's megabanks could see a reversal of fortune if the yield curve steepened just a bit.

For now, investors are staying out of the fray: Japan's yield spread has narrowed by only 6 basis points since Kuroda's speech. All they hear is blah, blah, blah. For now.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Adds Kuroda remark Tuesday in third-last paragraph. An earlier version corrected the date the governor took office.)

To contact the author of this story:
Shuli Ren in Hong Kong at sren38@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net