#Market Strategy — 21.09.2016

Has The BoJ Answered Investors’ Questions? Let’s See!

Guy Ertz

The Bank Of Japan proved it can be creative.

The kept the policy rate unchanged, abandoned the average maturity target of Japanese government bonds and instead introduced a yield curve control. This has lead Japanese banks to rebound. European banks also perform well this morning as there are speculations that the ECB could also target the yield curve. We see a limited impact for the yen short-term. The Fed guidance tonight could have a bigger and more lasting impact (yen weakness versus dollar).

Before the BoJ meeting

Japan has been struggling with weak growth, weak inflation, and paradoxically, a strong yen which affects companies’ competitiveness. The BoJ (Bank of Japan) has been trying to stop that dynamic with non-conventional monetary policy in addition to classic tools. In vain so far. The inflation is still at depressed levels and the yen remains strong.

The combination of rate cuts, with the introduction of negative rates, and the Quantitative and Qualitative Easing (Quantitative: the amount, target or range, and Qualitative: type of assets including maturity targeting), produced strong effects. It pushed yields of all maturities to an all-time low, with 2-15 year yields below zero and longer term rates close to zero. That was not without side effects though: negative yields and flat yield curve penalize the financial sector, with negative consequences for pension funds and long-term savers.

Recently, doubts on the efficiency of central bank’s policy pushed yields to rally: 2-year yields gained 0.10% from their lows, while the 10-year increased by 0.20% and the 30-year by 0.45%!

The BoJ currently owns 40% of the Japanese sovereign bond market, and soon 60% if it continues its purchases at this pace. It also owns about 65% of Japan’s domestic ETFs.

The BoJ decision

After being the first central bank to introduce the quantitative easing in 2001, the BoJ showed today how creative it can be to address issues.

On the non-conventional monetary policy (QQE), it abandoned its average maturity target and instead introduced a yield curve control. That means it maintains the government bonds purchase, but the pace of annual 80 trillion yen may fluctuate in the short term to control bond yields. The BoJ wants to keep the 10-year bond yield around 0%. The policy framework will continue until inflation is stable above 2%.

Regarding rate policy, the BoJ kept its policy-rate balance at -0.1%. That negative rate applies to some of the excess cash holdings held by the banks and parked with the central bank.

We believe the BoJ is actually preparing the ground in case of future yen appreciation. By controlling the yield curve, it can maintain it steep to limit the effect on banks. Should the yen surge in the future, it could therefore lower the policy-rate balance without hurting the financial system too much.

Initial market reactions:

The BoJ basically took control of the sovereign bond market thanks to the QQE with yield curve control. Japanese bond yields rose. 10-year yields gained about 5 bps to -0.02%.

The yen weakened against the dollar by about 1.0% to 102.73, and against the euro by some 0.80% to 114.19. The Fed decision later today will have more impact of the exchange rate, especially if it decides to hike (not our base case as we see a rate hike in December). We keep our USD/JPY 3-month target at 105, and 12-month target at 112.

Japanese stocks increased, especially banks (TOPIX banks index) which rallied 7%. European banks opened up this morning on speculation that the ECB could also adopt a yield curve target.