There may be method to his madness after all.
Japan's central banker, Haruhiko Kuroda, is a "nutter," in the eyes of exchange-traded fund provider Tobias Bland. That's what he told me ahead of a presentation on ETFs at the brokerage CLSA's Investors' Forum, running all week in Hong Kong.
The markets have applauded Kuroda's latest steps. The Bank of Japan (BOJ) on Wednesday changed tack in its bid to spark Japan's moribund economy to life. Facing steep criticism from banks and insurers after the BOJ introduced negative interest rates earlier this year, the bank is now targeting midterm interest rates in the form of yields on 10-year Japanese government bonds (JGBs). The central bank said it will do whatever it takes to keep them at zero.
Société Générale made the right call on Monday, ahead of the BOJ's two-day meeting. As I explained on Monday, it advised buying Japanese banks as a hedge against rising yields, despite all the pessimism about the troubled sector.
Japanese banks have been the major winners since the BOJ's announcement came out. The promise of a move out of negative rates on long bonds will enhance their profitability. Financials closed Wednesday up 5.7%, the top performers in the Topix, which rose 2.7%. The Nikkei 225 rose 1.9%, but is down 11.7% this year, with the Topix is down 12.6%. Markets were closed Thursday for the fall equinox holiday.
The hedge fund Horseman Capital Management has ridden a short position on Japanese banks to a 14% gain this year, the top-performing Japan-focused long/short fund, as Bloomberg explained. That type of hedge fund is averaging a 4% loss in 2016 (a hedge against the poor overall performance in Japan, but not a very good one). Horseman is targeting Japanese regional banks such as Shizuoka Bank (SHZUY) , Yamaguchi Financial Group T:8418 and San-In Godo Bank (SGDBF) . It believes some regional banks will go bankrupt in the next few years.
On Wednesday, other small banks were among the top gainers. Yamanashi Chuo Bank (YMSCF) (10.0%), Kyushu Financial Group (KYUNF) (10.0%) and Hiroshima Bank T:8379 (9.6%) were among the top-five stocks.
The BOJ also upped its inflation forecast, saying it would attempt to provoke inflation exceeding 2%, and deliberately overshoot, an advance on the flat 2% target it had set before. That would ultimately lead to higher interest rates that would also help improve bank profitability. Inflation is just 0.4% now despite the central bank's best efforts.
The bank kept in place its policy of buying ¥80 trillion ($790 billion) in JGBs, keeping fans of central-bank spending happy, although it said it would be flexible on the timeframe. It had previously pledged to spend ¥80 trillion each year. Removing the time limit basically means it can buy as much as it wants. That's actually essential, depending on what the market does, as the BOJ may need to buy no 10-year bonds at all, or an infinite amount, at least in theory.
Japan has never tried to target longer-term interest rates, and central banks in general are viewed as the setters of short-term rates alone. The United States attempted to keep long-term rates low after World War II to aid in the recovery.
Maintaining a negative interest rate of -0.1% on short-term rates, and buying enough bonds to sustain a rate of 0% on mid-term 10-year rates means that yields on 20-year, 30-year and 40-year bonds can rise. That helps banks with deposits paying hardly any interest because they can buy long-term bonds and make a profit on the spread over short-term bonds.
There had been speculation that the BOJ might push short-term rates as low as -0.3%, but it made no such move. It will continue to buy ¥6 trillion ($60 billion in ETFs and ¥90 billion ($890 million) in real-estate investment trusts every year, keeping that time constraint in place. But it said it would shift its ETF purchases into the broad Topix instead of buying stocks in the price-weighted Nikkei 225.
That process was distorting a small number of stocks, critics said. Obviously, the Nikkei contains 225 companies, whereas the Topix -- full name the Tokyo Stock Price Index -- contains all the stocks on Tokyo's First Section, almost 1,700 companies. The Topix is also weighted to reflect the market capitalization of the free float of the companies that it contains, whereas the Nikkei 225 is price-weighted, which creates weird distortions. CLSA's Japan Economist Nicholas Smith has called it "a Flintstone index from an abacus world."
Fast Retailing (FRCOY) , the parent of clothing store Uniqlo, is the biggest Nikkei 225 component because its shares are worth ¥33,000 ($328). But it makes up 8% of that index and just 0.3% of the Topix. The Japanese government now owns half the company's shares, according to Nomura.
Former U.S. Federal Reserve chief Ben Bernanke applauded the BOJ's moves, saying on his blog that it was "good news overall," although he said the risk to targeting 10-year bonds is that the BOJ could end up owning almost all of them. Flooding the market by buying huge amounts of bonds and ETFs has its limit, and many observers were worrying that Japan, with the highest debt load of any major economy, could not afford to continue with such a policy for much longer.
Bernanke visited Kuroda in July. Christopher Wood, CLSA's equity strategist, said at a media lunch today that "Kuroda and Abe are on the same page." He believes Shinzo Abe, as the most-powerful Japanese prime minister in recent history, has a good shot at pushing through his attempts to, for instance, reform Japan's labor market and even immigration. He has already won plaudits for forcing corporate reform and greater accountability among "Japan Inc." He is also pushing for greater participation in the workforce from women.
Plenty of people are watching. Japan is "the world's biggest laboratory for monetary policies," The Wall Street Journal said. Those in the markets are directly affected, and academics are equally interested to see what happens.
The markets reacted immediately. Not only did the banks drive overall equity gains, but the yen also weakened 1% immediately and has continued to drift lower today. It is now trading at ¥100.7 to the U.S. dollar, down 3.1% this month.
Abe, visiting Reuters in New York on his birthday on Wednesday, said he had three priorities: the economy, the economy, and the economy. He told his audience he would boost the wages of Japan's part-time workers, who make up about 40% of the work force.
We are now almost four years into Abenomics. The first two arrows, heavy fiscal and monetary spending, have been shot. The third arrow, structural reform, is far harder to shoot on target. "Abenomics is fighting against history," Robby Feldman, the chief economist at Morgan Stanley MUFG Securities in Tokyo, said in a video presentation before Abe's speech, as the Financial Times wrote. "The problem is that this is a journey of a thousand miles and we've only taken a couple of steps so far."