Despite the Bank of Japan’s recent assertion that it will attempt to control the yield curve on its domestic bonds, and thereby aid reeling Japanese banks, Goldman Sachs notes that it may not actually be possible.
In a note to clients analyzing yesterday’s big BOJ announcement, Goldman analyst Naohiko Baba calls into question the central bank’s prospects of following through on its ambitions:
“It is very unclear at this time exactly how the BOJ intends to ‘control’ the yield curve in the future. Based only on the official statement, we think it is likely it will maintain the yield curve at more or less the current level for the time being. However, the question is how it will control the overall level and shape of the curve when financial and economic conditions change in the future. While the JGB market needs to take time to study the BOJ’s intentions, with interest rate movements lessening, we think the pricing function of interest rates as a mirror reflecting real economic and financial conditions will be increasingly lost.”
It remains to be seen if the BOJ actually has a strategy for controlling the yield curve, because it certainly didn’t explain anything of the sort in its announcement yesterday. Meanwhile, the Japanese bond market will increasingly be a function of BOJ policy rather than normal market interactions. Goldman speculates that maintaining the current -0.1% interest rate while buying long-term bonds could be the BOJ’s strategy:
The BOJ emphasized that it has four means of easing at its disposal going forward: (1) the negative interest rate (short-term policy interest rate) on policy-rate balances in current accounts, (2) 10-year JGB yields (long-term interest rate), (3) expansion of asset purchases, and (4) expansion of the monetary base. The BOJ will continue to apply a negative rate of 0.1% for (1), while purchasing long-term JGBs so as to maintain long-term interest rates at around zero. We think the BOJ aims to control the yield curve by controlling these two interest rate targets, together with the introduction of new market operations as a backstop when interest rates rise. The BOJ decided to maintain the pace of JGB purchases at around ¥80 tn a year for the time being, but it has effectively abandoned its previous monetary base target.
Goldman also speculates that the BOJ has switched into managing expectations mode, and could be simply setting the stage for tapering its asset purchases in the distant future:
Governor Kuroda of course denied this, but we think the introduction of yield curve control could be considered as paving the way for future tapering of JGB purchases. We think it is likely that by substantially changing the framework, the BOJ aims to attract the market’s focus to yield curve control and slowly move toward tapering in the background. In addition to the high likelihood that it will become increasingly difficult to maintain its large-volume JGB purchase program for technical reasons, the marginal benefits from expanding JGB purchases have already diminished vs. costs involved, as we have repeatedly mentioned. However, as many market participants forecast the forex rate based on the monetary base ratio between two countries, there is an obvious large risk to reducing purchases. Accordingly, we think the BOJ has judged that it needs to divert the market’s attention as early as possible in advance. As we mention later, our impression is that an exit from unprecedented easing is now much more distant. In our view, the BOJ needed to minimize market shock accompanying a shift in policy targets and also make the easing system longer-lasting and more sustainable.
The bottom line is, the more things change, the more they stay the same. The BOJ has taken a cue from the Federal Reserve, it seems, by talking a lot but saying (and in this case, doing) very little.
The iShares MSCI Japan ETF (NYSE:EWJ), which closed up $0.36 (+2.93%) to $12.66 per share, was inactive in premarket trading Thursday. Year-to-date, the largest Japan-focused ETF by assets has risen 4.46%.