Bond, Gold surged on BOJ QE tapering plan and Putin's warning

·         BOJ holds rates at 0.30% repo rate (since 2008) as expected but indicated QE tapering for 2025-26; JGB/global bonds surged as Japan may issue less debts/bonds

On Friday (14th June), some focus of the market was also on BOJ after a hawkish hold by the Fed Wednesday, on the other side of the Pacific and also amid recent hawkish jawboning by BOJ/JP policymakers to hike rates after exiting NIRP (selective negative reverse repo rate) and YCC policy.

On Friday, as unanimously expected the BOJ kept all policy rates on hold; i.e. BOJ kept its Basic Loan Rate (repo rate) unchanged at +0.3% (since Dec 2008), while encouraging the uncollateralized overnight call rate to remain at around 0.0 to 0.1%. The BOJ ended the so-called 8-year-old super-powerful NIRP (negative reverse repo rate on CDF to encourage bank lending rather than disposing with BOJ) on March 24. The BOJ also scrapped its YCC policy officially after gaining confidence about reaching 2% inflation on a sustainable basis and an end to a deflationary mindset. The BOJ’s reverse repo rate was kept unchanged at +0.1% in June (interest paid by BOJ to banks on the CDF at a special current account maintained with BOJ).

In March’24, the BOJ also kept all policy rates unchanged, except the symbolic special reverse repo rate on the complimentary deposit facility (CDF). The Bank of Japan (BOJ) hiked its key short-term special deposit facility (reverse repo) key policy rate to +0.1% from prior -0.1% (since Dec’16) by a 7-2 vote. The BOJ has ended the so-called 8-year-old super-powerful NIRP (negative reverse repo rate on CDF to encourage bank lending rather than disposing with BOJ).

But in June, the BOJ indicated that it may consider the QE tapering mechanism in the July meeting; i.e. how to start reducing bond purchases at its July meeting. The move was passed by an 8-1 majority vote aiming to allow long-term rates to move more freely. The BOJ is currently buying about JPY 6T (around $0.4T) in JGB bonds per month. BOJ may continue to buy lower JGB bonds as per the QE tapering plan for the next 1-2 years (2025-26).

The BOJ July statement mentioned that Japan's economy had recovered moderately despite fragility in some areas. Private consumption was resilient amid improving corporate profits and business spending. Exports, however, have been flat, as did public investment. The Japanese annual CPI is now in the range of 2 to 2.5%, with inflation expectations rising modestly while underlying core CPI is expected to increase gradually.

Full Text of BOJ statement of monetary policy: 14th June’24

“At the Monetary Policy Meeting (MPM) held today, the Policy Board of the Bank of Japan decided, by a unanimous vote, to set the following guidelines for money market operations for the intermeeting period:

·         The Bank will encourage the uncollateralized overnight call rate to remain at around 0 to 0.1 percent

·         Regarding purchases of Japanese government bonds (JGBs), CP, and corporate bonds for the intermeeting period, the Bank will conduct the purchases in accordance with the decisions made at the March 2024 MPM

·         The Bank decided, by an 8-1 majority vote, that it would reduce its purchase amount of JGBs thereafter to ensure that long-term interest rates would be formed more freely in financial markets. It will collect views from market participants and, at the next MPM, will decide on a detailed plan for the reduction of its purchase amount during the next one to two years or so

Japan's economy has recovered moderately, although some weakness has been seen in part. Overseas economies have grown moderately on the whole. Exports have been more or less flat. Industrial production has been more or less flat as a trend, but it has continued to be pushed down recently by a suspension of production and shipment at some automakers.

With corporate profits improving, business fixed investment has been on a moderately increasing trend. The employment and income situation has improved moderately. Private consumption has been resilient, although the impact of price rises has remained and automobile sales have continued to be pushed down by the suspension of shipment at some automakers. Housing investment has been relatively weak. Public investment has been more or less flat. Financial conditions have been accommodative.

On the price front, the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) has been in the range of 2.0-2.5 percent recently, as services prices have continued to rise moderately, reflecting factors such as wage increases, although the effects of a pass-through to consumer prices of cost increases led by the past rise in import prices have waned. Inflation expectations have risen moderately

Japan's economy is likely to keep growing at a pace above its potential growth rate, with overseas economies continuing to grow moderately and as a virtuous cycle from income to spending gradually intensifies against the background of factors such as accommodative financial conditions. While the effects of the pass-through to consumer prices of cost increases led by the past rise in import prices are expected to wane, the year-on-year rate of increase in the CPI (all items less fresh food) is projected to be pushed up through fiscal 2025 by factors such as a warning of the effects of the government's economic measures pushing down CPI inflation.

Meanwhile, underlying CPI inflation is expected to increase gradually, since it is projected that the output gap will improve and that medium- to long-term inflation expectations will rise with a virtuous cycle between wages and prices continuing to intensify. In the second half of the projection period of the April 2024 Outlook for Economic Activity and Prices (Outlook Report), it is likely to be at a level that is generally consistent with the price stability target.

Concerning risks to the outlook, there remain high uncertainties surrounding Japan's economic activity and prices, including developments in overseas economic activity and prices, developments in commodity prices, and domestic firms' wage- and price-setting behavior. Under these circumstances, it is necessary to pay due attention to developments in financial and foreign exchange markets and their impact on Japan's economic activity and price,

Voting for the action: UEDA Kazuo, HIMINO Ryozo, UCHIDA Shinichi, ADACHI Seiji, NOGUCHI Asahi, NAKAGAWA Junko, TAKATA Hajime, and TAMURA Naoki. Voting against the action: NAKAMURA Toyoaki. While Nakamura Toyoaki was in favor of the idea of reducing the Bank's purchase amount of JGBs, he dissented, considering that the Bank should decide to reduce it after reassessing developments in economic activity and prices in the July 2024 Outlook Report”

Highlights of BOJ MPC and Govt. Ueda statement/Q&A: 12th June’24

·         BoJ Rate Decision Actual 0.10% (Forecast 0.1%, Previous 0.1%)

·         Japan's economy sees moderate recovery with some weakness observed

·         BOJ sees continued uncertainty in economic activity and prices

·         Bank of Japan trims bond buying to allow long-term interest rates to move freely

·         Yen continues to decline against the dollar following the BOJ decision

·         BOJ cuts bond buying to allow yields to form freely

·         BOJ emphasizes the importance of monitoring financial and forex markets

·         BOJ to hold bond market group meetings on Japanese government bond purchases

·         BOJ sees price trend to stay around target level in latter half of forecast

·         BOJ warns of the importance of monitoring foreign exchange and its effects on inflation

·         Bank of Japan's Nakamura votes against reducing bond purchases

·         BOJ to Survey Bond Market Group on Japanese Government Bond Purchases

·         BOJ to decrease government bond purchases

·         BOJ to decide on bond purchases in the next 1-2 years at their upcoming meeting

·         BOJ decision causes a slight drop in yen against the dollar

·         Plan for bond buying to be discussed at upcoming meeting

·         BoJ will conduct JGB purchases following a decision made at the March policy meeting

·         We decided to reduce JGB purchases to ensure long-term yields are formed more freely in the markets

·         It's appropriate to decide on bonds in a predictable manner

·         Prices are to move around the target in the 2nd half of the outlook span

·         We are paying close attention to the Yen's impact on prices

·         Japan's economic & price uncertainties remain high

·         The reduction of JGB purchases will be a considerable volume

·         The specific amount and framework of JGB purchase reduction will be decided while listening to market participants' input

·         We will start a reduction of JGB purchases immediately after deciding at the next policy meeting

·         We will raise rates if prices rise towards the target

·         Monetary easing from JGB buying's stock effect will continue to work while we reduce bond holdings

·         It's conceivable to adjust rates earlier if the price outlook is revised up or if upside risks heighten

·         A rate hike is justified if upside risks intensify

·         Every day we check FX moves, the sustainability of the moves, the impact on domestic prices, and wages

·         I can't say the specific timing of a potential hike in advance

·         Will begin tapering bond purchases immediately after the July meeting

·         We will adjust rates if underlying inflation rises toward 2%, but cannot comment now when that will become evident

·         I don't think we can reach the state of JGB holdings that is desirable in the long term in a year

·         We will set the short-term interest rate at July's meeting, also considering JGB purchase reduction

·         There is no change in the view that consumer spending will pick up

·         We announced the JGB purchase reduction today to avoid uncertainties until the July meeting as much as possible

·         Will adjust rates if underlying inflation rises towards the 2% target

·         A rate hike in July is naturally possible depending on the data

·         We are watching if cost-push inflation is coming back

·         The price trend is a little below 2%

·         Spreading wage hikes will be reflected in a further rise in service prices

·         There are some transitory elements in inflation

·         Won't comment on forex moves when asked when the Yen's weakness might be reversed

·         We will use short-term rates as the main policy tool

·         will continue to closely monitor the FX market

·         No comment on the possible market impact of BOJ's decision

·         There has been no change to the view on the long-term neutral rate

·         We want to narrow the range of the neutral rate of interest, but the estimation does not seem to conclude soon enough for policymaking

·         I cannot comment on how big a large bond tapering is

·         Whether monetary easing leads to a true virtuous cycle depends on the rate of productivity increase

·         We will adjust rates if underlying inflation rises toward 2%, but cannot comment now when that will become evident

·         I don't think the balance sheet would be in favorable shape in 1-2 years

·         I don't think we can reach the state of JGB holdings that is desirable in the long term in a year

·         We will set the short-term interest rate at July's meeting, also considering JGB purchase reduction

·         The pre-announcement today is an exceptional measure; the decision to do so is to avoid confusion and uncertainty before next month

·         Whether monetary easing leads to a true virtuous cycle depends on the rate of productivity increase

Market impact:

Overall, after the Fed’s hawkish hold on Wednesday, BOJ also for a hawkish hold on Friday in the sense that it will taper QE (bond buying), which may prompt the Japanese government to issue debt/bond earlier estimated. As Japan is the global exporter of capital due to the very low interest/bond coupon rate regime back home, the surge in Japanese bonds also caused a similar surge in US and EU/European bonds; i.e. global/US bond yields slumped.

As a result, Gold surged, while Wall Street Futures also got some boost and recovered from the Fed panic low. Additionally, Gold was also boosted by Russian President Putin’s jawboning and prediction about a ‘doomsday’; subsequently Wall Street stock Futures as well- as European futures also tumbled. Also, the bond yield spread between Germany and France/Italy/Southern EU jumped on growing election/political uncertainty, especially in France as Macron’s Party may lose the election this time.

On Friday, Wall Street Futures eventually closed almost flat after less hawkish Jawboning by Fed’s Goolsbee and Mester, expressing about stronger USD amid growing policy divergence with ECB, and BOC as the latter goes for one symbolic rate cut ahead of the election (domestic political compulsion), while Fed may only go for the eleven rate cuts cycles from Dec’24 QTR, after the Nov’24 US Presidential Election to keep both Democrats and Republicans in ‘good mood’; Powell has to again face Trump tantrum in 2025! Amy way, USD surged on growing policy divergence on both sides of the Atlantic and Pacific.

Conclusion:

Despite the unexpected indication of BOJ QE tapering, there is a huge policy divergence between the Fed and BOJ. If we adjust the average core inflation, the real U.S. /Fed repo rate is now around +1.70% against BOJ/Japan’s -3.00%. Also, BOJ is still doing QE, while Fed is on QT. This is causing huge JPY depreciation against USD and even EUR, and GBP, causing a vitreous cycle of higher imported inflation and stagflation despite the advantage in exports. Also, geopolitical tensions with Russia and China are causing significant supply chain disruptions in Japan, causing more imbalances between demand and constrained supply.

As per Taylor’s rule, for Japan:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(4.00-2.00) =0+2+2=4.00%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation=4.00% (2023 average)

As per Taylor’s rule, Japan’s repo rate should be around 4.00% instead of the present +0.30%. Even if we assume a potential output growth gap of around -1%, Japan’s repo rate should be around +3.00% in the long run (by 2025-26); although BOJ thinks at present there is no output gap and the Japanese economy is now growing as per its potential +2% almost around +1.9% in 2023.

Normally, a Central Bank should do its job to bring down inflation/ensure price stability by hiking rates into the restrictive zone (real positive rate) so that the resultant higher borrowing costs curtail demand/consumer spending, corporate and even government spending; i.e. creating some slack and allowing constrained supply side of the economy to match lower demand, and ultimately inflation normalizes/falls. This is exactly what is being done by the Fed, ECB, BOE, and almost all other G20 central banks, where core inflation is still running hot.

A central bank (monetary authority) has policy tools that may affect only the demand side of the inflation equation, while fiscal authority (governments) has policy tools not only for the supply side but also for the demand side through various policies and targeted fiscal stimulus (grants/subsidies). For effective inflation management, both monetery and fiscal authority should act/coordinate effectively. But despite that BOJ/Japan Government is not ready to hike or even normalize/exit the current ultra-easy monetary policy as Japan is the only among few major economies in G10, that is paying around 12-15% of its tax revenue as interest on a huge public debt against U.S. 15% and EU/China’s 5.5%, far ahead of the AEs, which is a red flag and thus despite various narratives, BOJ is not in a position to normalize policy rate even after core inflation jumped to above +4.0% in May’23; BOJ is consistently referring elevated inflation post-COVID, primarily due to higher USD, higher imported inflation and lower supply.

Japan/BOJ has no option but to keep the bond yield/coupon rate at an artificially ultra-low level to keep borrowing costs minimal, so that it does not go above the 15% of the revenue red line. Japan/BOJ improved the borrowing cost ratio to 11.67% in FY22 from 13.50% in FY21 (due to improved revenue). BOJ now holds almost 50% of the total JP public debt.

But decades of artificially lower bond yield environment are also weakening Japan’s bank & financials, wage growths, and overall consumer spending. Japan is now in a deflationary to a stagflationary cycle. If core inflation continues to surge and becomes sticky/elevated around 5%, then BOJ’s ultra-easy monetary policy may cause more devaluation for the currency/Yen and cause more imported inflation, everything being equal (despite BOJ/Japanese government jawboning that they are ‘watching’ Yen movement). The never ending deficit, debt, and devaluation are affecting the Japanese economy despite higher USD, favorable for any export-heavy economy.

In Mar’24, the BOJ normalized its symbolic special reverse repo rate of -0.10% to +0.10% without and repo rate hike and quitting JGB buying (QE). Looking ahead, BOJ may start hiking the repo rate, presently at +0.30% in H2CY24 by +25 bps to match possible Fed action when the Fed starts to cut from DFec’24, which will cause lower policy differential, lower USDJPY, lower imported inflation, higher JGB bond yields, higher NIM/NII for banks & financials and higher wage growths and an end of the vicious cycle of deflation (?). But looking into the B/S of BOJ and Fed, the policy differential is still huge as the Fed is in now QT mode, while BOJ is still in QE mode, having a repo rate of +0.30% against the Fed’s +5.50%.

Although, BOJ was famous for its negative interest rate policy (NIRP) narrative (bluff), in reality, the effective reverse repo rate was already around 0% or +0.10% in Mar’24, while the repo rate was +0.30% and no banks ever make the ‘complementary deposit’ above a certain limit in a special current account with BOJ, so that it has to pay an interest of +0.10% to BOJ under reverse repo rather than the usual opposite.

BOJ’s repo rate is still now +0.30% (unchanged since Dec’2008) against the Fed’s current rate of +5.50% and ECB’s +4.50% despite comparable core CPI; BOJ was trying to keep the 10YJGB bond yield at minimum levels, now below +1.0% by sheer jawboning and a false perception of a negative interest rate; in reality, BOJ’s repo rate was +0.30% against Fed’s +5.50%, while the effective reverse repo rate +0.10% against Fed’s +5.40%.

In this way, due to the very low repo rate, reverse repo rate, and bank lending rate, banks & financials have very low NIM compared to their US peers, leading to subdued wage growth and the vicious cycle of deflation. BOJ officially maintained a negative reverse repo rate (tiered), so that banks are discouraged from parking their excess funds at BOJ and encouraged to lend to the real economy (forced lending policy is the World’s financier, especially in US bonds, startups, and infra projects).

Overall USDJPY is under stress as it did not indicate any repo rate hike till now and continued the QE. The yen plummeted despite the BOJ ending the world's final negative interest-rate policy (NIRP) as the BOJ emphasized those financial conditions would remain favorable. While the BOJ formally discontinued its YCC, it committed to continue purchasing long-term government debt; i.e. just shifted from QQE to QE.

Looking ahead, whatever may be the narrative, technically, USDJPY (157.31) now has to sustain over 159.00 for a further rally to 160-165; otherwise, sustaining below 158.50 may again fall to 155.00-153.50 in the coming days.