Today's US presidential debate was a distraction with a short lifespan compared with far bigger forces at play in financial markets. Photo: iStock
had been perilously close to 100.00 as the day’s trading began but picked up as the debate progressed, rising to 100.80, while US stock market futures also found a mild bid.
Meanwhile, traders mulled over a speech given by the Bank of Japan Governor, Haruhiko Kuroda, explaining last week’s decision to “strengthen the existing framework for monetary easing” by introducing price control to the world’s second-largest bond market.
The governor claimed quantitative easing in Japan
had been a success but that “despite a positive turnaround, the price stability target of 2% had not been achieved”.
Previously he had put the blame on declining oil prices but now says the key reason lies in developments in inflation expectations; specifically that they were backward-looking, taking their lead from past and present inflation levels, rather than being forward-looking in accordance with the BoJ’s commitment to do whatever it takes to reach, and perhaps temporarily exceed, 2%.
Therefore, said Kuroda, “it is necessary to dramatically change people’s outlook for prices”.
Easier said than done, especially when, as the bank concedes, the “deflationary mindset” that has plagued Japan for two decades has not yet been overcome.
The solution they came up with after a “comprehensive review” of monetary policy was to “facilitate the formation of a yield curve which is deemed most appropriate for achieving the price stability target of 2% through the appropriate combination of a negative interest rate and Japanese government bond
Thus yield curve control is the core element of the new policy framework. Initially, the deposit rate will stay at –0.1% while the operating target for 10-year JGBs will be “more or less the current level, around zero percent”.
The chart below shows the current shape of the JGB yield curve with the 10-year rate sitting very close to the zero target. The chart also shows the significant decline in rates right across the curve since the introduction of the negative interest rate policy (NIRP) last January.
Rates have backed up a bit since the summer when the curve flattened right out, close to zero in all maturities – a move described as “excessive” by Kuroda because, while a fall in lending rates had been intended, they had fallen faster than bank deposit rates, thereby adversely effecting financial institutions profits.
Japan yield curve
It’s a basic rule in economics that you can control the price of a commodity or the supply, but not both simultaneously.
So it was surprising last week to hear the BoJ say it wants to hold the yield on the 10-year JGB “more or less” around zero percent while at the same time conducting purchases of JGBs “more or less” in line with the previously announced pace (80tn yen per month).
Probably it would have preferred to omit any JGB purchase target but would have been aware some analysts would have latched onto this as representing a “tapering” of QE and that’s certainly not an intention it wished to convey.
Kuroda expanded on this point in yesterday’s speech, saying “it is anticipated that the pace (of JGB purchases) may fluctuate to some extent, either upward or downward, in order to achieve yield curve control. Therefore a possible change in the amount of purchases has no policy implications”.
As for what the BoJ will do if things don’t work out the way they hope, Kuroda said the options for additional easing are (1) further cuts in the negative short-term policy interest rate; (2) lowering the target level of the longer-term interest rate; or (3) acceleration in the expansion of the monetary base (in which case interest rates would likely decline significantly, regardless of yield curve control)
On Friday we will get an update on just on how well things are working out via the Consumer Price Index. The current situation, outlined in the chart below, is not expected to change much. Analysts expect the numbers will show annual headline inflation still declining at a rate of 0.5%.
What should we make of it all? Will the BoJ’s price fixing policy suffer the same fate as the Swiss National Bank’s EURCHF peg, causing chaos in global markets?
How much credibility should we give to the BoJ’s statement that “in the case of a spike in interest rates, the bank stands ready ... to prevent the yield curve from deviating substantially from the current levels”?
And what of capital flows? Will outflows from Japan further blow out the dollar-yen cross currency basis, forcing institutional investors to buy US assets without a currency hedge, thereby providing support for USDJPY? (I’ll write an explanation of how that all fits together in a follow-up article).
It was notable that Kuroda’s speech didn’t mention the exchange rate once: it seems the market is much more fixated on the level of USDJPY than the Bank of Japan.
The Trump-Clinton debate gave USDJPY a small boost, as it did to US stock market futures. As this coincided with a decline in Trump’s chances, according to betting sites, we have to assume a Clinton win would be a positive for the dollar and the stock market.
But much bigger forces are at play and will now move to centre stage. The Bank of Japan’s new approach to monetary policy is perhaps the most important force of all.
– Edited by Susan McDonald
Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform.