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Bank of Japan policy shift: Waiting for the other shoe to drop?

Jitu Naidu, Investment Communications Manager
Masahiko Loo, Investment Director
2023-01-31
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There is a growing consensus that Japan has reached several inflection points: the critical 150-per-dollar level for the yen — its lowest in more than three decades — and 10-year Japanese government bonds (JGBs) trading above their 25 basis-point (bp) yield-curve control (YCC) cap, along with limited signs of a meaningful fall in global (ex-Japan) inflation anytime soon. The underlying message is that many overseas investors now view a Bank of Japan (BoJ) policy shift from its ultra-accommodative stance as inevitable in order to stem the yen’s slide, especially after the Ministry of Finance’s (MoF’s) yen-buying intervention failed (unsurprisingly) to provide more than a temporary respite from the currency’s persistent weakness.

Figure 1
  Japanese investors’ view*  Global investors’ view
US recession timing 2Q23, induced by Fed hiking into “restrictive” territory Gradual slowdown skewed toward 4Q23, supported by tight labor market
US Fed’s terminal rate 4.75% – 5.00% 5.25% – 5.50% 
$JPY MoF defends 150 handle-line; $JPY falls back to 130 on BoJ policy tweak(s) $JPY goes to 160 if terminal US rate >5% with JPY weakness “sticky” (structural)
Japan inflation “One-off” inflationary pressures, contained at around 3% and peaking in 2Q23 Inflation likely to be problematic, following in the footsteps of US and Europe (where inflation was initially dismissed as “transitory”)
BoJ policy Gradual, orderly fine-tuning of BoJ policy post Kuroda 10-yr YCC won’t last until April 2023 (when Kuroda’s term is up)

Sources: Wellington Management, Bloomberg. *Based on a Bloomberg survey of Japanese economists and conversations with Wellington Management’s Japanese client base.

Notably, domestic Japanese investors seem to have some distinctly different opinions than their global investor counterparts, with the former mostly in line with BoJ Governor Kuroda’s view around “one-off” inflationary pressures and no imminent need for a BoJ policy adjustment (Figure 1).

Our latest view and potential market implications

By way of comparison and context, consider the US, where the labor market remains very resilient. Recent policy rhetoric suggests that the US Federal Reserve (Fed) is rethinking its trend-growth estimates (i.e., significantly lower than previously thought), given the lack of increases in labor force supply and productivity. At present, the US economy appears to be further above trend than the Fed previously assumed, making even more policy tightening likely to be necessary to get inflation sustainably down toward the Fed’s 2% target. To that end, the Fed may be inclined to hold rates “higher for longer” and project a higher terminal federal funds rate, even if it signals a slower pace of rate hikes ahead.  

As a result, we think the pressure on the BoJ to at least “tweak” its monetary policy strategy relatively soon will keep building. In the absence of such a change in policy, the yen will likely continue to depreciate going forward. On inflation, the consensus view right now is that putting in place heavy energy regulations/subsidies and food import controls would help to keep inflation in Japan lower versus its global peers. However, should the yen stay weak for an extended period of time, Japan’s inflation might prove stickier at higher levels, due in large part to imported inflation (whereby elevated prices for imported commodities cause a country’s overall inflation to rise).

What could alleviate pressure on the BoJ to act? 

  • We believe that current MoF and BoJ policy operations are essentially ”buying time,” hoping that pressure on the BoJ to join the global rate-hiking cycle will subside if conditions play out in favor of the prevailing domestic Japanese view — that is, if US/global inflation peaks and concerns about the global economy entering a recession help to “cap” US/global yields, including JGB yields. Alternatively, a gradual policy shift by the BoJ next year could lessen BoJ-Fed policy divergence, helping to partially unwind some of the catalysts contributing to the yen’s weakness versus the greenback.  
  • Looking ahead, however, the main concern is whether Japanese policymakers have a “plan B” to tackle the situation if the global view (see above) turns out to be right. We believe markets will continue to price in possible BoJ policy tweaks in the near term, despite Kuroda’s strong bias toward maintaining the status quo. Global investors increasingly regard the BoJ’s still-dovish rhetoric with skepticism, especially when once-dovish peers such as the European Central Bank (ECB) and the Swiss National Bank (SNB) have begun moving into the policy normalization camp.    

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