In early May the Japanese celebrate a week-long holiday, ‘Golden Week’. Perhaps it was officials’ desire to get a head start on the holiday period, but on 28 April the Bank of Japan (BoJ) decided not to provide fresh stimulus to Japan’s ailing economy. Not for the first time, it has also pushed back the timeframe for meeting its 2 per cent inflation target by a further six months.
To us this is akin to a doctor looking at a patient’s chart in the hospital, reading vital signs that were poor – though not critical – and deciding more medicine was not required, with the old medicine needing more time to work.
Or probably even worse, that the previous medicine – negative interest rates, large-scale purchases of government debt and domestic equities via ETFs with ‘printed’ money – had larger-than-expected side effects.
Surprise, surprise…
The BoJ prides itself on being able to surprise the market. Historically, these have tended to be ‘upside’ surprises, but under BoJ head Haruhiko Kuroda, these have more recently been to the downside. The main reason given for the lack of extra stimulus was to give existing policies more time to work. It was also made clear that the central bank did not want to work in increments.
Performance of index over 5yrs
Source: FE Analytics
On 28 April, the market reaction told a tale of dissatisfaction: equity markets fell and the yen pushed higher, indicating an expectation of easing had been priced into markets.
Aside from the short-term reaction, why should investors care about what the Bank of Japan is doing?
Japan has a very large amount of debt: Measured on a gross basis, the public debt as a percentage of GDP is around 250 per cent. More and more of this debt is owned by the BoJ, bought by ‘printed’ money. The situation could persist for a number of years without any problems, but periods of calm can be ended by a sudden explosion.
Global policymakers are watching: Policymakers aim to learn from the mistakes of other countries. The negative reaction to negative interest rates in Japan led the ECB to offer discount loans to European banks when it lowered rates further.
If the unconventional tools used by Europe and Japan don’t work, it will reinforce US policy makers’ commitment to leave rates lower for longer to make sure that low inflation doesn’t become permanent. That’s good for fixed income assets.
Japan is the world’s third-largest economy: For global growth to lift, it needs all engines firing. Japanese trend growth has been 0 per cent for years, with Abenomics designed to lift this into positive territory; failure to do so will mean another lost decade.
Japan is also the world’s fifth largest exporter and importer in the world. Continued volatility of its currency and a change in its terms of trade has implications beyond its shores.
Performance of currencies over 3yrs
Source: FE Analytics
What comes next?
We believe the BoJ will need to do more given inflation is unlikely to meet its revised forecasts. Given the cost of stopping before its goals are achieved, the BoJ may well act and surprise the market with a ‘shock and awe’ policy package of measures as soon as the June meeting.
This could possibly coincide with the ‘helicopter money’ of increased fiscal stimulus. Whether there was some practical or political obstruction to action this time round, it simply adds to the swelling expectation that more stimulus will be added at the next opportunity – and the longer the BoJ waits, the more extraordinary this will need to be.
In this light we still see value in a long equity and short currency position in Japan. Clearly these positions took a blow last week, with the yen hitting an 18-month high earlier this month. Though painful, we believe the probability weighted path for both trades is firmly up from here.
While the actions of the BoJ on the global stage have been less influential than those of the Fed and ECB, investors may start to doubt the impact of further easing from central banks in general.
Is there any juice left to squeeze out of the QE orange, or has it dried up, with the Bank of Japan the first to notice? Something for Kuroda to think about.
Emiel van den Heiligenberg is head of asset allocation at Legal & General Investment Management. The views expressed above are his own and should not be taken as investment advice.
