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There is no BoJ Pivot Coming
One of the bigger macro themes this year in markets has been the remarkable moves in the Japanese Yen. Year to date, USDJPY is up over 10%, trade weighted Yen is down 8.5% and is down over 10% since the beginning of March. Of course the catalyst for this Yen weakness has been the very significant moves we have seen in global fixed income and commodity prices this year. In a year where the Fed/BoC/RBNZ will be hiking at 50bp increments, the ECB will be hiking out of NIRP (negative interest rate policy) and global yields are up over 100bps, Japan’s policy of yield curve control (YCC) has been pushed to the edge.
The question now is how much more Yen weakness is the BoJ willing to tolerate, and is this weeks BoJ meeting a catalyst for a policy shift?
Is change coming from the BoJ? Kurdo’s pre meeting speech basically said no.
Going into this weeks meeting the BoJ has at least set the stage to continue YCC, or that any changes will be on their terms. The Bank of Japan has conducted fixed-rate purchase operations for “consecutive days” into this weeks monetary policy meeting (MPM). The idea likely being that the BoJ wanted some relative calm in the market at least going into the meeting.
The last speech we got from Governor Kuroda before the MPM this week was last week at Columbia University. And there really was not much change in tone from Kuroda at all.
To anticipate my conclusion, Japan's inflation rate may be at around 2 percent for the time being, due mainly to a rise in energy prices. However, inflation in Japan differs significantly from that in the United States in terms of magnitude, spread, and economic conditions behind the rise in inflation. Therefore, it is my view that the Bank should persistently continue with the current aggressive monetary easing toward achieving the price stability target of 2 percent in a stable manner.
The output gap is still negative, and economic overheating has not been of concern.
Even taking into consideration price developments in Japan, it is reasonable to continue with monetary easing. Although inflation is expected to rise in the short run, such a rise consists primarily of cost-push inflation and therefore lacks sustainability.
Then, what about when the increase in commodity prices heightens inflation expectations through its second-round effects and sets off a rising wage-price spiral? In some cases, a central bank needs to respond with monetary tightening. In fact, central banks in the United States and Europe have decided to adjust monetary easing, and my understanding is that this is due to vigilance against such second-round effects. However, in Japan, it is unlikely that the current rise in commodity prices due to supply factors will immediately lead to a sustained rise in wages and prices. This is because Japan imports most of its resources and demand-pull inflationary pressure in the economy is weak.
The Bank's role in the current context is perfectly clear: to persistently continue with the current monetary easing centered on yield curve control. By doing so, it will firmly support the economic recovery from the pandemic and encourage the formation of a virtuous cycle in which both wages and prices rise moderately.
There has been no real change in Kuroda’s stance on BoJ policy this year, despite the massive moves we have seen in the Yen this year.
What’s Kuroda saying:
Japanese CPI will get to 2% this year as base effects from things like mobile phone prices drop out. However, Kuroda has seemingly telegraphed that he is still not convinced it will be “sustainably” at 2% and without that stopping policy easing is premature. The BoJ has a super core measure type they use and it is still showing readings between 0.5-1.5%. Well below the 2% target.
The BoJ still believes that the output gap in Japan is negative. Which almost innately means that they don’t think inflation above 2% is sustainable as there is still slack in the economy. Inflation in Japan is entirely cost push in the BoJ’s view.
According to Kuroda, there are no second order effects for Japan. I.e. part of the reason that global central banks have had to shift so aggressively to inflation, even though energy prices/supply side factors have played a big role in the elevated readings, is because there has become risk of high spot inflation leaking into longer term inflation expectations. Kuroda does not think that inflation expectations in Japan are at risk from the current elevated levels of energy price pressure.
Kuroda also seems to be taking the BoE’s approach to the real income squeeze. This is the idea that cost push inflation can be resolved via lower consumer spending via a reduction in real incomes. I.e. another reason why inflation expectations are not at risk. “As Japan is a commodity importer, a rise in commodity prices pushes down the economy through a decrease in households' real income and corporate profits.”
Kuroda still thinks a weak JPY is fundamentally good for Japan’s economy. He has been clear about that in front of the Diet in Japan last month."There's no change now to my view a weak yen is generally positive for Japan's economy." This is despite survey evidence that recent JPY moves have been too volatile for the Japanese economy. A recent Reuters poll found that 76% of firms said they can't tolerate yen weakness at current levels. The BoJ has not shared this sentiment.
There is no big BoJ shift coming
In terms of the sequencing, any BoJ shift will start with the statement. And that could happen as early as this week. The end of the current BoJ statement is:
“For the time being, the Bank will closely monitor the impact of COVID-19 and will not hesitate to take additional easing measures if necessary, and also it expects short- and long-term policy interest rates to remain at their present or lower levels.”
The BoJ could change the language toward the end in terms “present or lower levels.” Or, the BoJ could drop the entire easing bias of “or lower levels” and “not hesitate to take additional easing measures.”
The BoJ could drop this easing bias and Kuroda made clear in his April 22nd speech that no further easing is required. However, in terms of JPY, how is any of this going to be JPY supportive? We are still someways out from the BoJ adjusting the YCC band, let alone getting rid of it. And this is all in a world where global fixed income has been crushed this year. Yen is not going to get bailed out by the BoJ. Sure, they may eventually move the band, but ANY YCC in a world where fixed income is melting down is too much YCC.
Overall: The pressure on JPY is not over.
There is no big BoJ pivot coming. A shift in the statement, or even an eventual shift in the YCC band are both far too incremental relative to the backdrop of commodity prices and rising global interest rates.
The Kishida government has introduced new easing measures worth over $100b to deal with energy price pressures. Easing monetary and easing fiscal, is not usually positive for FX.
Global fixed income is not only re-rating to higher level but settling into a higher range. I.e. this cycle for many central banks, neutral is the floor of the cycle not the ceiling it was in the 2010s. And in this backdrop, of neutral plus monetary policy, elevated fixed income volatility and 50bp rate hikes, the 10y JGB yield is pegged at 25bps. FX has to be the outlet for that.
To me, USDJPY dips will continue to be bought. The level of JPY in which Kuroda is motivated to shift still seems to be OTM (out of the money).