BOJ: On Course for QE Exit

Published on October 19, 2018

Bank of Japan watchers are paying especially close attention to a study paper released by the BOJ on October 1 that analyzes the impact of quantitative easing on the markets and economy.

The paper, which mirrors the debate within the Federal Reserve before it started to taper its own QE program years ago, essentially concludes that the compression of bond term premia is driven 90% by “stock effects” (the impact of the stock of bonds held out of the markets and in the BOJ portfolio), and only 10% by “flow effects” (the impact of the net increase in monthly purchases of JGBs by the BOJ).

*** This paper is being highlighted to us as laying the framework for an eventual and more forceful exit of the Bank of Japan from its truly enormous – by any proportional measures – QE program, and from its continued net new purchases of JGBs. It comes on the heels of the BOJ’s gradual and stealth tapering of its purchases on the longer end of the bond markets, which has effectively steepened the curve and loosened up the longer end JGB markets as we had been flagging since the turn of this year. ***

*** This stock vs flow argument  and its rather emphatic and bold conclusion on the relative importance of “stock” versus “flow” to bond yields and markets in effect lays the groundwork for the assertion that so long as the BOJ keeps its massive stock of bond holdings relatively intact, it can continue to (gradually) reduce its monthly net additional purchases of bonds, without dampening the impact of its already extensive monetary easing on Japan’s financial markets and the economy. ***

And that study was then followed by some unusually frank comments by Bank of Japan Governor Haruhiko Kuroda.

An Unusual “Kuroda Tell”

In addition to the paper, comments made by Governor Kuroda on the sidelines of the October 13 IMF and World Bank Meetings in Nusa Dua Bali, Indonesia, have also raised some eyebrows, in seeming to confirm the BOJ is indeed now finally embarked on the slow, but steady, path towards normalization — or as is fashionably called in markets these days, “Quantitative Tightening.”

In his public remarks, Kuroda noted that a rise in bond yields “will” be the first sign for markets that that the BOJ is “finally” ready to start the process of exiting its massive monetary policy stimulus. Eyebrows were raised on two counts:

For one, it is hard not to take notice that yields have already (and deliberately) been slowly allowed to creep higher – at least in the longer end of the bond market.

Second, it is highly unusual for the ever cautious and steady-handed Kuroda to talk so openly, and looking to be opening the door deliberately to a discussion of the long-awaited exit strategy. But the time is now clearly ripe – if not long over-due.

The BOJ, of course, will be in no rush to head for the exits, but the path has been, and continues to be clear, and perhaps more to the point, is now increasingly more openly being acknowledged, clarified, and communicated.

As one first part of that process, the BOJ has finally admitted that a numerical annual 80-trillion-yen target for purchases of JGBs is totally inconsistent with the much more flexible, and appropriate, policy of guiding purchases with the objective of managing a specific rate target – Yield Curve Control.

And so the BOJ has dropped the pretense that it is or can simultaneously pursue both these targets at the same time – with full focus now on YCC. That earlier, theological sounding duality was the height of unnecessary, and one might argue confused cautiousness in messaging. The BOJ policy path, and objective, is now thankfully all that much more consistent and clear.

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