The Bank Of Japan At The End Of The Road

I doubt this needed underscoring, but just in case: Years of the easiest monetary policy imaginable, including an ETF-buying program that’s left the central bank as the largest holder of domestic equities, has not translated into inflation in the world’s third-largest economy.

I wasn’t going to dedicate a separate piece to this as it’s just par for the proverbial course, but ultimately, I think it bears mentioning.

Japan’s preferred gauge of consumer prices dropped at the swiftest pace in a decade last month, the latest figures, out Friday, showed. The 0.9% decline in CPI excluding fresh food was in line with consensus, which in this context actually says a lot, considering inflation is partly a function of expectations.

As noted in the chart header, this is intractable. Yes, there are pandemic effects in play, but the deflationary mindset in Japan is entrenched, and if cornering the government bond market and pseudo-nationalizing the stock market isn’t enough to break the spell, it’s probably safe to say that getting the job done will require something truly dramatic, especially given the extent to which the Bank of Japan is also fighting demographics, a battle which arguably cannot be won.

On Friday, at its last meeting of the year, the BoJ kept policy largely unchanged, although they did extend pandemic programs for businesses. It what was billed as a “surprise,” Kuroda said the bank would conduct a review of its policies, although he emphasized there’s no plan to alter the commitment to the 2% price target. The bank will look at the management of yield-curve control and asset purchases, Kuroda said, noting that the review is more a matter of fine-tuning than overhauling. The bank is not looking for an exit from its current policies, he remarked.

Again, this was pitched as a “surprise” by the media, but to the extent the goal is to figure out a way to make the policies more sustainable and effective, it’s not clear why anyone should be taken aback by a decision to conduct a review — after all, these policies aren’t sustainable and they aren’t effective either.

Absent an exogenous shock or a policy maneuver dramatic enough to shake things up, there’s virtually no chance of the BoJ hitting its inflation target anytime in the foreseeable future. Given that, the question is straightforward: Is it possible that the day will come when the continuation of these policies finally “breaks” something, whether that means the JGB market slips into a coma from which it never emerges, banks lose patience with thinner margins, or Kuroda ends up in some kind of ridiculous position vis-à-vis corporates due to the sheer size of the bank’s equity stakes?

“It’s true this is an extraordinary policy for a central bank,” Kuroda said Friday, commenting on the BOJ’s ETF purchases. Including unrealized gains, he owned 45 trillion yen worth of Japanese stocks as of last month.

“It’s therefore necessary to examine ways to make this step effective and sustainable,” Kuroda added.

The results of the bank’s “review” will be unveiled in March.

One potential issue — and this speaks to how absurd things really are — is a stronger yen. The ECB and the Fed are committed to “lower forever” (basically) and both are poised to keep buying assets in perpetuity. So, if the BoJ doesn’t at last make overtures to tweaking something (even if it’s just for show), the market could test their resolve on the excuse that, despite the size of its balance sheet as a percentage of GDP, the BoJ is relatively “hawkish” on a kind of “what have you done for me lately” interpretation.

With the dollar sitting at multi-year lows and analysts rolling out a hodgepodge of rationales for why it “should” keep falling, views on the yen are coalescing around the notion that a move below 100 (on dollar-yen) is likely. At that point, the country’s exporters would lose money, and the stronger currency would jeopardize an already tenuous recovery.

The breakeven dollar-yen rate for exporters last year was 100.20 (see the visual at the bottom of page two here.)

With yields likely to remain depressed across fixed income markets outside of Japan, it’s not clear that low yields at home will be as effective when it comes to providing an incentive for local investors to flee domestic assets. That could reduce structural depreciation pressure. With the government borrowing to fund more stimulus, there’s also scope for increased supply to push up yields, which could exacerbate the situation.

“We think it’s understandable that the central bank now feels obliged to make excuses on why the 2% inflation target has not yet been achieved,” Credit Suisse said Friday. “The forthcoming assessment report will be something that reconfirms the bank’s reluctance on taking another bold step on easing even if it continues to miss the target.”

With apologies, “bold steps” are probably necessary. This is the end of the road. There’s no way out of this for the BoJ. I think everyone knows that by now. It may be time to either toss out the inflation target as unachievable or else resort to “shock and awe” — e.g., canceling some JGBs held by the BoJ just to send a message.