Earlier this month, SocGen’s Albert Edwards suggested that the next market shock might well emanate from Japan.
More specifically, Edwards said a shift the country’s deflationary mindset coupled with robust econ might well prompt the BoJ to take the first baby steps down the road to policy normalization.
“Could things be going so well in Japan that an unexpected tightening causes the yen to surge at a time when almost all investors, including myself, expect neverending yen weakness?”, Edwards asked, in his latest note to clients. Here’s the chart which shows that while inflation remains subdued, the “spell” may be breaking in terms of the psychology:
Conveniently, Edwards’ note was released amid news that the BoJ pared purchases of 10-25Y JGBs. That added fuel to the fire in terms of the selloff in US Treasurys, yields on which rose to 9-month highs the day after the BoJ news hit. Since then, 10Y yields in the U.S. have risen steadily, breaking above 2.60 on Thursday, the highest since March.
Between the BoJ news and persistent dollar weakness tied to jitters about a possible government shutdown stateside, USDJPY has fallen through 111:
Well according to a new piece in the Wall Street Journal, called “Bank of Japan Looks to Massage Its Message as Inflation Edges Up,” the BoJ is indeed feeling better about its ever-elusive inflation target. To wit:
The Bank of Japan is optimistic about hitting its 2% inflation target within two years and is considering how best to communicate any possible policy changes, say people familiar with its thinking.
As the central bank prepares for its first policy meeting of 2018 on Monday and Tuesday, insiders see more signs that inflation is on the right track. Core inflation—all prices excluding fresh food—rose 0.9% in November, and corporate leaders have expressed openness toward larger wage increases this spring, when annual talks with labor unions take place.
Needless to say, that’s likely to fan the flames in terms of speculation about whether the predictably “boring” BoJ is about to get more exciting and thereby become a source of uncertainty for markets.
As BofAML reminds you, the BoJ has reduced its JGB purchases under YCC. “Purchases of long-term JGBs were ¥80tn in 2015 and ¥79tn in 2016, but declined to only ¥58tn in 2017,” the bank notes, in a piece dated Friday. This trend is likely to continue.
But here’s the thing. The market’s outsized reaction to the ¥10bn reduction in purchases earlier this month will probably serve to make Kuroda more cautious going forward and thereby more careful in how he “massages” his message (to quote WSJ). “It could be seen as a good experience teaching the bank that proper communication is needed,” a person close to the bank said.
Right. And remember: Kuroda has always said that JGB purchases will vary and it is by no means clear that the reportedly more rosy outlook on the inflation front is warranted.
Given all of that, it seems unlikely that the bank is going to risk too much in the near-term, especially considering how comparatively complex the policy mix already is. Here’s BofAML again:
The price action on 9 January is a reminder that even tiny moves by the BoJ can trigger significant market reactions if its communication with the markets is not effective and credible. In addition to the lack of clarity on sequencing, the BoJ’s communication challenge is exacerbated by the complexity of its monetary policy program and weakness of its forward guidance. For example, in September 2016, the central bank introduced its 2% inflation “overshooting commitment” alongside YCC. But the commitment is a pledge to continue expanding the monetary base until 2% inflation is achieved in a sustainable manner: it says nothing about the shape of the “optimal” yield curve. This leaves open the possibility that YCC may be adjusted before inflation reaches target.
See what I mean? This is going to be one hell of a communications challenge considering no one really understands what they’re doing in the first place and also considering the extent to which they’ve effectively cornered the JGB market.
In any event, Albert Edwards is correct to suggest that this may end up being a kind of black swan event should the BoJ bungle the messaging.
But lest you should get too worried, remember that “what we need is a positive attitude and conviction.”
Now here’s a fun picture of Kuroda giving you the seductive eye while seated in a dark room where the only light is a blue lava lamp…