Thursday, 4 April 2013

Monetary Samurai

Image: Library of Congress
The Bank of Japan (BoJ) announced today that it will expand its monetary easing programme by buying 7 trillion yen per month.

The BoJ will give up targeting the interest rate with its existing operations and will, instead, target the monetary base which it intends to increase at a rate of 60-70 trillion yen per year (doubling it by the end of 2014).

The range of maturities being bought will also increase, probably double, and may include 40 year maturities. Lengthening maturities lowers longer term borrowing costs and is perceived as increasing the effect of mere liquidity provision at shorter maturities.

The yen has fallen more than 3% at the time of writing, unwinding a week and a half’s worth of gains. Prime Minister Abe’s comments about the difficulties of meeting the 2% inflation target over two years now appear to have been a means of tempering market expectations before unleashing shock and awe.

Japanese equities rallied 4% on the news, Japanese Government Bonds (JGBs) fell even closer to record lows and the curve steepened significantly – 30 year JGBs were up nearly 5% at the close and yield less than 1.3%.

What is clear is that this is a concerted effort which is being eloquently stage-managed for maximum effect. We also understand that there is a tremendous sense of support for such radical policy actions from the Ministry of Finance, Bank of Japan, and the Japanese private sector. Desperate times, it seems, call for desperate measures.

The unofficial triumvirate of policies is a lower yen, higher stock prices and higher nominal wages. The investment implications, therefore, continue to appear favourable as actions such as today’s announcement seem well capable of achieving the first two. Our concern remains with the third which would impact on Japan’s real economic performance.

First, there has been no follow through from the weaker yen to trade improved trade data, or for that matter inflation data. Perhaps four months into a significant depreciation we should not be surprised by that. The initial impact would generally be a deterioration in terms of trade as import costs increase before tradable goods prices fall in export markets.

Second, we remain concerned about the ability of the Japanese government to persuade businesses to pass on higher nominal wages as their margins get squeezed or eradicated by higher import costs (particularly energy).

The Abenomics solution to this challenge is twofold. Coercion via the Keidanren (the Japanese Business Federation) and more formally a tax break on increases in wages. We are cautious on the success of these policies given the challenges faced by businesses. Nevertheless, for now at least the sun continues to rise in Japan.

Guy Foster
Head of Portfolio Strategy

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