It's not often that a central bank can move markets by doing absolutely nothing. But that's exactly what has happened today.
The Bank of Japan ended its two-day policy meeting by standing pat on its super-lax monetary policy. It kept interest rates the same, with the short-term rate in negative territory at -0.1%. The BOJ maintains mid-term rates at around 0.0% in the form of the 10-year yield.
Traders have been testing the BOJ, betting it would abandon its tactic of easy-to-free lending. What is that they say about not fighting the Fed? It seems that is not lost in translation in Tokyo.
The Japanese central bank surprised markets when it made a tiny tweak of its policy in mid-December, a move you may recall I said at the time makes the case for holding unhedged Japanese equities. The tweak was to allow the yield on the 10-year Japanese government bond to trade in a slightly wider band between -0.50% and 0.50%, up from between -0.25% and 0.25%. But beyond those minutiae, it was more important that the central bank changed its policy at all.
Some traders and pundits saw the writing on the wall for the BOJ's era of easy money. This, they bet, was the first step toward abandoning the policy, ahead of a sea change when current BOJ Governor Haruhiko Kuroda steps down in April.
So they put on bets that the yield curve would have to widen some more, starting today. Over and over, they pushed the 10-year yield beyond the limits of what the BOJ said it would accept. There were many predictions before the conclusion of today's meeting that today would start the big shift.
It did not. As I said in December, I think the BOJ acted then to alleviate a little of the pressure on its extremely weak currency, and to buy itself time so it can keep easy money going for longer. I still stick to that call.
Today, the speculators and prognosticators have been proved wrong. The BOJ did not scrap its policies, and looks set to continue them at least until April, and potentially - with tweaks to the details (as above) - beyond. The traders have had to unwind their speculative bets in a hurry.
The BOJ kept the yield curve at the same level, and continues to promise to buy Japanese government bonds in whatever quantity necessary to sustain that. It will also purchase exchange-traded funds and Japanese real-estate investment trusts as necessary, as well as corporate bonds. The "smart money" was that it could no longer afford to keep that stream of purchasing going. It turned out to be a dumb call.
Japanese equities, which had been going nowhere, jumped after the BOJ meeting ended, at an extremely precise 11:33 a.m., according to its minutes! The broad-market Topix came out of the lunch break with a bang, and rallied all afternoon to close with a 1.7% advance. The Dow-like Nikkei 225 blue-chip index gained 2.5%. The Japanese yen suddenly weakened, moving from ¥128 against the U.S. dollar to ¥131.
I think the BOJ has made the right call. While Japan's inflation, at 3.8% as of November, is at its highest rate since 1981, that is largely the result of higher fuel and import prices, in a country that imports all its oil. It was a Middle East oil crisis that led to those high prices in 1981, too... The extreme weakness of the Japanese currency hasn't helped, with oil traded in expensive dollars, and all components, parts and foreign-made goods costlier to ship in.
Despite today's reverse move, the yen has now strengthened dramatically from above ¥150 to the U.S. dollar in October to around ¥130 now. That 13.6% improvement takes the heat out of imports and oil.
What's more, the November inflation numbers, the latest available, represent an extremely modest advance on the 3.7% rate for October. It appears inflation will soon peak, if it has not already. And let's not forget both the BOJ and the Japanese government have been battling for years to actually create inflation of around 2.0% in Japan, which has suffered the better part of three "lost decades" given up to deflation, which eats away at all aspects of your business and consumer activity.
The BOJ also today gave its January forecast for the Japanese economy in the next two years. Despite Covid, high commodity prices and slowdowns in overseas export destinations, the bank expects a "virtuous cycle" to develop in Japan, as income and spending improve. This should lead to positive growth trends, and outperformance.
But the central bankers are nervous about outside elements, specifically a potential recession in the West, the war in Ukraine, energy and commodity prices, not to mention the unpredictable pattern of Covid, particularly now China has suddenly thrown the zero-Covid shackles off and let the disease rip.
On the positive side, the BOJ says wages in Japan are finally increasing, something that has stubbornly refused to budge. Japanese employees should see their take-home pay rise "moderately," so they should feel confident to increase their spending even in the face of inflation. There's also plenty of pent-up demand and savings produced by the pandemic. What's more, the government is trying to offset the worst of household worries with measures to reduce gasoline prices, electricity charges and gas-supply costs. It is also offering a subsidy for domestic travel, of up to ¥7,000 (US$54) per night for Japanese residents.
When you cut out energy costs and its effects, Japanese inflation ran around 2% in 2022, should be between 1.5% and 2.0% in 2023, and slow slightly to around 1.5% in 2024. If it has been double-digit price hikes in Europe and the peak 9.1% rate from June in the United States that's encouraged Western central banks to hike interest rates and end the era of easy money. Those pressures aren't occurring in Japan.
Reading those BOJ conclusions, it looks like Japan is set for modest growth, modest income increases, modest but welcome inflation... and continued support from the Bank of Japan.
Traders got it wrong today - the Japanese central bank seems to love catching them out - but compared to the recession-bound West, it should be a period of quiet, calm growth in the next couple of years for Japanese markets, supported by a strengthening yen.
