The BOJ’s current round of communication troubles dates back to Dec 20 when it allowed interest rates to go higher in a surprise move, sparking a rally in the yen and in the shares of major banks and insurers that could profit from higher yields.
When the Japanese central bank failed to follow through with additional action on Jan 18, many investors reversed their bets and shook their heads, wondering how to make sense of a BOJ that had teased them only weeks before with the prospect of a major policy shift.
“The fact that the market swings is an indication that the market doesn’t know what the BOJ is going to do,” says Joseph Kraft, CEO of Tokyo-based Rorschach Advisory.
Takeo Kamai, head of equity trading at brokerage house CLSA in Tokyo, said the Japanese markets have become “more of a gamble.”
“We are not quite sure where we are headed,” he said. “Although there is probably a growing consensus that the BOJ’s monetary policy will change, it’s only speculative.”
The impasse recalls recent developments in the US financial markets. The Fed has signalled that it is likely to raise its policy rate from 4.25-4.5% to 5-5.25% and keep it there for a year. But the market is pricing in three rate cuts instead. “I don’t know if the Fed is doing a bad job communicating or the market just doesn’t want to listen, but there is clearly a gap,” Kraft said.
Market players in Tokyo place the blame for the BOJ’s messaging issues on its governor, Haruhiko Kuroda, who is due to retire on April 8 after holding the post for the last 10 years.
Kuroda was instrumental in introducing in 2016 the yield curve control framework, under which 10-year yields are pegged at zero and short-term rates at minus 0.1%. Last year, the policy fanned yen selling, sending the Japanese currency down 23% at one point, as investors dumped yen for dollars to buy higher-yielding US Treasury securities. The rigid framework forced the BOJ to buy almost all available Japanese government bonds (JGBs) to keep interest rates from rising, leaving the market with almost no buyer other than the central bank.
To address the dysfunction, Kuroda decided in December to allow 10-year yields to move in a band between plus or minus 0.5%, instead of 0.25%. But the underlying problems were unresolved – and that remained the case after the BOJ’s board met Jan 17-18.
“What Kuroda said in December was that he wants to address market dysfunctions. The market is still dysfunctional. The market assumed they should act. Then they didn’t,” Kraft said. “That confuses the market.”
Kuroda was unapologetic. “There is nothing unusual about market players forming different views from the central bank,” he quipped in a press conference on Wednesday.
But Toshifumi Umezawa, investment strategist at Pictet Asset Management (Japan), described the current policy as unsustainable, saying there is still a gap between the BOJ’s yield level target and the level considered “fair” by the market.
“Until we know how the policy will be changed, it will be difficult to invest actively in Japanese stocks,” he said.
The uncertainty also has roiled the market for Japanese corporate bonds, where a host of new issues had to be postponed this month as volatility dented investor appetite.
Naoki Kamiyama, chief strategist at Nikko Asset Management, said investors are holding off on purchases because they are unsure about how BOJ policy will affect the pricing of corporate bonds, which typically have durations of five to seven years.
“There is speculation that the BOJ will target five-year yields instead of 10-year for its operations. Unless investors know what the BOJ is going to do, they cannot invest with the same level of confidence as they did before,” Kamiyama stressed.
Not all investors are deterred by the volatility. Japanese life insurers, the biggest investors in JGBs after the BOJ with a 20% share, are finding JGBs more attractive because of their higher yields, said Teruki Morinaga, director of credit analysis at Fitch Ratings.
Japanese life insurers currently keep around 35% of their portfolios in JGBs and around 30% in foreign bonds such as Treasuries. Now, they are more inclined toward super-long JGBs, such as 20-year notes, which offer a return of 1.3% compared with almost nothing three years ago.
JGBs have an added attraction under Japanese accounting rules because they do not have to be marked to market, unlike US Treasury bonds, Morinaga added. Japanese investors suffered losses on their Treasury holdings last year as interest rates jumped. If JGB yields keep rising, the shift to them from T-bonds will gain momentum, Morinaga predicted. “Interest in JGBs has never been so strong in the last few years.”
To attract additional investors, market players are hoping for more clarity on monetary policy – from a new BOJ governor. The government of Prime Minister Fumio Kishida is set to submit the candidate’s name to parliament in February.
No matter what the BOJ said last week, many market participants believe that Kuroda has finally set in motion the process of monetary policy normalisation.
“It could be an indication that Japan is finally overcoming its deflationary mindset,” said Kamiyama of Nikko Asset Management.