Why does this matter for global investors?
In effect, the contraction in global liquidity has stopped, and even reversed, as the BoJ’s bond purchases dwarf the US Federal Reserve’s (Fed’s) quantitative tightening (QT) measures. Because the BoJ has been forced to buy assets aggressively to defend the new 10-year YCC band, Global QE is rising at its fastest pace since mid-2021. This accelerating central bank liquidity partly explains the fall in bond yields and the bounce in risk assets we have seen so far this year.
Why do we think policy change is imminent?
The main characters are changing — Japan has a relatively new prime minister and the current BoJ governor is due to retire on April 8. Neither Prime Minister Fumio Kishida or the yet-to-be-nominated new governor will be tied to the “inflation at all costs” strategy set out by former PM Shinzo Abe and Governor Kuroda. Forward guidance has become irrelevant as markets are no longer confident in the BoJ’s reaction function.
Macroeconomic conditions suggest change is needed — The BoJ is defending a yield that looks increasingly inappropriate for the cyclical outlook and, hence, is unsustainable. Its unexpected shift at the December meeting implied unease at the BoJ about expanding its balance sheet while exiting ultra-loose policy. Meanwhile, the outcome of the January meeting suggests that the bank is still not fully convinced that inflation is now sustainable.
The cost of bond buying looks unsustainable — Core inflation is running at a 40-year high and 2023 may see the Japanese economy record its second-strongest year of nominal growth since 1991. This leaves the BoJ in the wrong place, defending an increasingly problematic yield peg at a spiralling cost. It has cited an unrealised loss potentially as high as JPY 28 trillion (equivalent to 5.2% of GDP) as a consequence of buying up bonds to curb the 1% parallel move in the JGB curve that occurred in early December 2022, while the amount spent trying to defend the 0.5% 10-year yield target peg may have exceeded JPY 17 trillion to date. Moreover, the BoJ currently owns 50% of outstanding JGBs and its holdings are likely to reach 60% by mid-year at the current pace of purchases.