Lab Work

It’s not clear, to me anyway, why they bothered.

I’m sure “BOJ watchers” spent the last five hours combing through the results of the bank’s policy review in an effort to extract nuance and notables, but on a quick scan, it all seemed like tinkering. Tweaks to a never-ending experiment.

Don’t misconstrue that. Tinkering can be meaningful when it emanates from central banks. Sometimes, ostensible “tweaks” can trigger the butterfly effect.

Maybe some of the tweaks unveiled by the BOJ on Friday will do just that, but the bank appeared to go out of its way to suggest that some of the steps it took didn’t actually amount to changes. Most notably, the bank finally specified what the band is for 10-year yields. They can fluctuate 25bps on either side of zero. That was tipped (i.e., deliberately leaked) earlier this week, and the market had, of course, always assumed it was 20bps, so the announcement was hardly groundbreaking.

Amusingly, Haruhiko Kuroda told a reporter that despite the band being widened, there was no such widening. The BOJ didn’t widen the range, he said. Rather, it just “clarified” how the bank thinks about the band. Earlier this month, Kuroda said he didn’t see the need to widen the allowable range of movement.

Read more: Who’s Boss

You’d certainly be inclined to think the market will test how high the BoJ will let yields go considering recent events.

Apparently, the market will zoom in on the 20-year, thanks to page 44 in the review. “The response of consumer confidence to decline in interest rates indicates that a decline in borrowing rates has a positive impact on consumer sentiment, while a decline in super-long-term interest rates has a negative impact,” reads a box found nearly four-dozen pages in. That isn’t “new,” per se, but the singling out of the 20-year (figure below) may be.

“Traders may decide the BOJ will be on the other side of the table when it comes to going long 20-years,” Bloomberg’s Stephen Spratt said, adding that “the spot has been a very popular carry trade for Japan’s banks, which look[ed] to be slowly unraveling” following the release of the review.

As far as the ETF purchases, the bank scrapped the 6 trillion yen annual target as expected (that too was tipped earlier this week). An upper-limit of 12 trillion yen remains, but the focus will shift exclusively to the Topix.

“The Bank’s indirect shareholding ratio in some ETF component firms tends to increase much more rapidly through such purchases in the case of ETFs tracking the Nikkei 225… than ETFs tracking the Tokyo Stock Price Index,” the review said, addressing one (of many) concerns about the bank’s mammoth stock portfolio. The BOJ nodded to criticism that “when the Bank holds ETFs, this will weaken business discipline in the management of individual firms.”

Unsurprisingly, Uniqlo operator Fast Retailing (the largest Nikkei stock) was crushed and the Nikkei-Topix ratio dropped precipitously (figure below). For some, Fast Retailing represents the quintessential example of the distortions created by the bank’s ETF-buying program.

The language from the review underscores the notion that the BOJ’s purchases are most effective when stocks are in free fall or when markets are experiencing acute volatility.

“[Our] results are consistent with the view of market participants [which] indicate that, during periods of market instability such as when stock prices decline or volatility heightens, ETF purchases by the Bank draw the market’s attention and are seen as a positive factor for the stock market,” the BOJ said, adding that “on the other hand, when the market is stable, they lose its attention and fewer market participants see such purchases as positive.”

The BOJ is now a value investor, I suppose. In addition to the emphasis on getting the most “bang for the buck,” some suggested the exclusive focus on the Topix will have serious ramifications from a style perspective. Bloomberg cited Shogo Maekawa, a strategist at JPMorgan Asset Management in Tokyo. “The mood in the market had already been in favor of the Topix, which tends to have more cheap valuation stocks, whereas the Nikkei 225 has more growth stocks,” Maekawa remarked. Another strategist said Friday that “the Nikkei 225’s relative outperformance against the Topix which has continued for 15 years is coming to an end.”

In addition to the above, the BOJ introduced tweaks, schemes, and incentives designed to dispel the notion it can’t cut rates further.

All of this is indicative of how difficult it is to micromanage capital markets and asset prices. The BOJ appeared to be communicating a flexible approach that could mean buying fewer assets, but it also leaves plenty of scope to buy more and also to ease even further.

One thing’s for sure: It underscores the extent to which markets are administered. The BOJ pioneered many of the experiments currently being conducted across the developed world. The results of the bank’s review perhaps provide a window into the future. Eventually, it’ll all be administered and the only thing for analysts to do will be to assess periodic tinkering and tweaks.

Summary from BOJ