On Friday, the Bank of Japan tweaked their bond buying program for September. Although they upped the purchase sizes across maturities, they reduced the frequency of purchase operations from five to six.
Going into July, the market was conditioned to view BoJ meetings as snoozers given that Japan is still miles away when it comes to bringing inflation up to target. Five years into ultra accommodative policy and they’re not even halfway there.
But the deleterious side effects of easing are showing up in bank margins and JGB liquidity and some folks are concerned about the long-term implications of the bank’s ETF program for the Japanese equity market. So, caught between a rock and hard place, the BoJ attempted to tweak policy at its July meeting.
The July 31 announcement came after two weeks of volatility in the normally sleepy JGB market. On July 22, 10Y JGB yields exploded higher in response to a JiJi newswire story that tipped a possible change in the BoJ’s thinking on yield curve control. The bond selloff forced the BoJ to step in with three fixed-rate operations in the week ahead of the policy meeting as yields continued to bump up against 0.11% in anticipation of possible tweaks. The frequency of those ops was unprecedented:
That episode highlighted the dilemma facing the central bank. The market is so thin that even the perception that small tweaks are in the cards has the potential to catalyze outsized moves. Perhaps more worrying, subtle shifts in policymaker rhetoric this year have been met with sharp rallies in the yen. That latter point is key. Yen appreciation undermines the inflation targeting effort and the currency’s safe haven status means it’s prone to rallying during bouts of risk-off sentiment. Additionally, political turmoil in Japan is a catalyst for yen appreciation given that any threat to Abe is seen as a threat to his namesake economic strategy.
The takeaway there is that the BoJ is effectively trapped. The institution of YCC led directly to the so-called “stealth taper” in JGB purchases, which only adds to market angst around any overt policy tweaks.
Late last month, as part of the tweaks announced after the July policy meeting, the BoJ said they would allow for more “upward and downward movement” in 10Y yields, but the market hasn’t responded. Since the late July volatility, the market has flatlined.
On Wednesday, for the first time since the July BoJ meeting, no 10Y JGBs traded.
That’s the backdrop for Friday’s announcement that the central bank will be reducing the frequency of purchases this month. The news sent JGB futures lower in a knee-jerk reaction.
The announcement tips a further willingness on Kuroda’s part to taper, but the concurrent move to up potential purchase sizes across maturities “suggests the BOJ would be wiling to buy more if necessary, given it’s unclear how the market will respond to the reduced frequency”, Mizuho wrote on Friday.
And see, that gets at the heart of the problem here. As detailed above, the market is hyper-sensitive to these tweaks and even a hint of normalization from the BoJ has the potential to lead to undesirable yen strength and acute bouts of volatility in the absurdly thin bond market. “Unless [the bank] increases purchases at the first operation [in September], the lower frequency will be taken as a plan to cut overall purchases”, Mizuho added.
All of this is compounded further by demographic trends in Japan and it seems like just a matter of time before this entire house of cards ends up necessitating actual “helicopter money.” To be sure, the concept of helicopter money has come up time and again in the context of Japan, but given the ongoing debate about how (or, more appropriately “if”) the BoJ will ever be able to exit accommodation, it’s worth highlighting a few excerpts from a new note by BNP.
The piece is lengthy and it’s impossible to do it justice here, but it can generally be summarized by excerpting some passages about net national savings and documenting the read-through for the BoJ. Here’s BNP walking you through net national savings and where Japan stands:
National net savings, being the net savings in the entire economy in flow terms, is an indicator of an increase in nation’s wealth. Net national savings is divided into net private savings and net government savings, with the former being further divided into net household savings and net corporate savings. Net household savings is the sum total of income earned by households plus social security benefits (etc.) minus consumption expenditures, taxes, and social security burdens. Net corporate savings is revenue minus current expenditures (capital expenditure such as investment is not deducted), and this corresponds to an increase in retained earnings. Net government savings is the revenue from taxes and social security burdens minus current expenditures such as government final expenditures and social security benefits. In short, net savings is the income that is not consumed. The reason is “net” is because it excludes capital depreciation, which is the depreciation of assets held.
Currently, net private sector savings remain at a relatively high level, as the increased net savings of corporations offsets the falling net savings of households. But the problem is that the net savings position for the government is substantially negative (= massive net dis-savings), owing to surging social security benefits. As a result, net national savings have sharply declined, owing to the consumption of net private sector savings by the government’s massive dis-savings. Although net national savings have currently improved to almost 5% of GDP thanks to the ongoing expansion phase, the trend itself is a downward trajectory. Thus, with social security benefits continuing to grow, while net household savings are expected to further shrink, net national savings will sooner or later likely fall into negative territory.
Ok, so hopefully you can see where this is going. If net national savings goes negative, someone is going to have to finance that gap if consumption is expected to remain steady. You can borrow money from foreign investors, but if your debt-to-GDP ratio is high and rates rise, well then keeping up with interest payments is going to be a nightmare.
Enter the BoJ and their never-ending quest to bring inflation to target.
“Given the fact that the BoJ has expanded its balance sheet to such unprecedented proportions and still cannot generate inflation, some might feel that the BoJ need only finance the deficiency in net national savings by purchasing government debt”, BNP goes on to write, before noting the obvious, which is that “when net national savings fall into negative territory, the BoJ’s large-scale buying of government bonds will mean that the BoJ has finally started financing the government’s current deficit, which cannot be covered by net private savings.”
In case that’s in any way unclear, the bank drives the point home in the simplest possible terms:
In other words, true helicopter money drop will begin.
When would this start to occur? Well, according to BNP, in the mid-2020s or, if Japan is lucky, around 2035. To wit:
But if the BoJ directly underwrites JGBs or if the BoJ provides the financing to private financial institutions to buy JGBs, high inflation would definitely be generated because fiscal funds would be newly issued to the government that are completely independent of net private savings. Will this kind of situation come into view from the mid2020s? Even if Japan is fortunate enough to get through the “2022-25 problem” unscathed, weathering through the “2035 problem” won’t be easy. That is when the remaining baby boomers will start entering the super-elderly 85+ population in droves, and the necessity of fulltime nursing care will oblige the boomer juniors to leave employment to care for their parents. Thus, due to the resulting drop in income, net national savings will further decline.
If you read all of the above and get the idea that Japan is a ticking fiscal time bomb or that, in the best case scenario, the only way to kick the can is for the BoJ to simply persist in accommodation quite literally forever, you’re not alone.
I’m not generally a doomsayer when it comes to Japan, but year after year after year, the country seems to find a way to dodge economic and demographic reality. At some point, you have to think that’s going to catch up with them.