Japan, a little like my British homeland, has a set way that many things simply must be done. It thrives on manners and tradition. Surprise isn't exactly the order of the day.
So when you get a surprise from the stodgiest of stodgy Japanese institutions, the Bank of Japan, it is, well, quite the surprise! A collector's item.
And we got one on Tuesday that the markets are still trying to digest. The actual content of the surprise isn't exciting - the BOJ slightly tweaked the yield-curve control on Japanese government bonds (JGBs) to allow long-term yields to rise a little. However, no one saw it coming. The markets, investors, the mythical Mrs. and Mrs. Watanabe, everyone expected absolutely no change in BOJ policy until the current governor, Haruhiko Kuroda, ends his term next year.
Kuroda will step down on April 8,and it's likely his successor will be nominated in February, after Japan's parliament reconvenes in January. It's also likely that the new governor will initiate a policy review, although the BOJ is still likely thereafter to continue to look to stimulate the economy and inflation through easy money.
Stocks lurched lower in Japan yesterday and continue to fall here on Wednesday. The broad-market Topix is down 2.6% since Tuesday lunchtime in Tokyo, most of the dip coming in the hour after the lunchtime BOJ statement. The large-cap Nikkei 225 is off 3.4%.
Those declines are nothing compared to the immense volatility we have seen in China as it imposes then scraps its zero-Covid policy and now looks set for a very harsh and disease-plagued winter. But the BOJ has shaken a little of the certainty surrounding Japanese equities, which have held up relatively well over the last 18 months. After two days of losses, the Topix is now 6.7% lower in 2022 compared with a 20.3% decline in the S&P 500.
Analysts are furiously reworking their projections for 2023 to allow greater latitude in BOJ policy, particularly when it comes to JGBs. By slashing interest rates and government bond yields to zero or even into negative territory, the BOJ has been trying to wean Japanese institutions off their fallback position, which is to pump money into JGBs no matter what they cost. That habit of buying JGBs robs other corners of the capital markets of cash. Companies don't benefit from investment that might help them expand production and employment. An extra institutional allocation to the stock market would partly explain the firmness of Japanese stocks.
The yen strengthened significantly immediately after the BOJ's move because it makes it more attractive relatively speaking to hold yen assets. The currency immediately moved from ¥137 to the U.S. dollar to ¥133. Today it is trading in Asia at ¥131.66, a dramatic improvement from its weak point in October, when it traded north of ¥150 to the greenback. Those levels hadn't been seen since 1990, but the yen has now firmed up 12.3%.
I don't advise trying to time foreign currency markets because moves such as what we've seen today and yesterday come out of the blue with instant and unpredictable impact. However, we can say that the direction of yen strengthening appears clear, particularly if we are close to calling time on the U.S. Federal Reserve's interest rate hiking cycle.
We are therefore likely in the unusual situation where it will pay U.S. investors to hold unhedged yen stocks and other assets in 2023. They would get an additional boost from the currency translation if the yen continues to strengthen against the U.S. dollar. It is highly likely that the yen will firm up further toward the ¥120 level.
In terms of specifics, the BOJ simply said coming out of its Dec. 20 meeting that it would widen the range that it will allow for the yields of 10-year JGBs, from between -0.25% and 0.25% to between -0.50% and 0.50%. That's hardly earthshattering. The BOJ left actual interest rates unchanged, though the tweak allows for slightly higher rates in practice. Short-term interest rates stay at -0.1%.
Banks and banking stocks would be the prime direct beneficiary of the change. Life insurers, sensitive to interest rates because they have long-term obligations, also stand to gain.
Property stocks are the inverse, suffering when interest rates rise. And real estate stocks were the worst-performing sector after the announcement.
Kuroda explicitly said the BOJ's move "is neither a tightening nor a step toward an exit" from hyper-accommodative monetary policy. It intends the slight change to breathe a little life into the JGB market, which is dead because those bonds basically pay nothing.
The BOJ, like the People's Bank of China, has been an outlier central bank that is not in a tightening cycle. The tweak shows it does have a bit of flexibility at the edges of an easy policy. Market watchers also indicate it could be a baby step toward a different type of monetary stance. Some analysts predict a rate rise could be in the cards next year after the new governor takes over.
I think the move, easing a little of the pressure caused by failing to raise rates, makes it more sustainable to keep interest rates low for longer. While Japanese inflation hit a four-decade high of 3.6% for October, that's largely due to higher commodity and energy prices in a country that imports all its oil. The BOJ is still desperately keen to ensure inflation of 2% or so sets in in order to ensure the Japanese economy leaves the destructive curse of deflation well behind it.
Japan was groundbreaking when it switched to negative interest rates, a strategy that many central banks then pursued in the wake of Covid. It's likely to keep short-term rates negative with the midterm 10-year rate around 0%. But this sudden move did spark some life in the yen while the yield on the 10-year JGB jumped from 0.25% to the newly allowed 0.46%.
Current Deputy Governor Masayoshi Amamiya is the frontrunner to take over. Nicknamed "Mr. BOJ," he would hardly be the man to radically shake up the central bank's policy. He has been a key player in the BOJ's battle to end deflation.
If Japanese Prime Minister Fumio Kishida wants to move BOJ policy in a slightly different direction, he could turn to former deputy governor Hiroshi Nakaso. Nakaso, now the chairman of the Daiwa Institute of Research think tank, also served under Kuroda but has published a book this year outlining what it might look like for the BOJ to exit its current policies.
Both Amamiya and Nakaso have been the right-hand man to Kuroda, who was appointed by late prime minister Shinzo Abe. They've therefore been firing that first arrow of "Abenomics," to pump the Japanese economy with easy money. Kishida will likely put forward a list of candidates in February for the Japanese parliament to consider in March. Kishida's party controls both houses of congress, so his candidate should cakewalk into the post.