What's 20 trillion yen between friends?
“More or less”
The Bank of Japan is trying to convince the market that there is “nothing to see here” despite a sharp drop in its asset purchase flow from ¥80 trillion to ¥60 trillion per annum. Add this to the list of reasons to worry about potential yen appreciation, but don’t think of it as a leading concern for global rates or risk assets.
The Bank of Japan (BoJ) has lots of extremely well educated economists among its 4,600 staff. However, in their public pronouncements, BoJ officials seem to overlook some of the basic lessons from microeconomics. In particular, the custodians of Japan’s monetary stability are keen to gloss over the section of their undergraduate textbooks on how to successfully operate a monopoly.
A monopolist can choose to fix either the market price of its goods or the quantity it provides. It cannot fix both. Fixing the price means that the quantity of goods sold will fluctuate with changes in demand. Fixing the amount supplied means that prices (not volumes) fluctuate. Hoping to fix both is like howling at the moon.
The declining pace of Japanese asset purchases is part of the global trend towards ‘quantitative tightening’
So why is this relevant for the residents of Nihonbashi-Hongokucho in Tokyo? Since September 2016, the Bank of Japan has operated a framework of “quantitative and qualitative easing with yield curve control” (QQEWYCC). This framework introduced a troubling dual commitment to fix both prices and quantities:
In practice, this policy has successfully pegged 10-year yields in Japan at close to zero ever since. But, as shown in the chart below, the quantity commitment is starting to fall apart.
The BoJ has reiterated the commitment to keep purchases running at “more or less the current pace” at each of the last eleven monetary policy meetings. In reality, they are seriously stretching a sensible definition of “more or less”: the annual run rate has dropped by 25% to ¥60 trillion. As demand has changed, the amount supplied has also changed in order to maintain a fixed price.
Does this matter? Concerns about the potential for a bout of unwelcome yen appreciation are presumably the reason the BoJ insists on maintaining its public commitment to a quantity target. But at some point in the not too distant future, they will have stretched the linguistic elastic of “more or less” beyond breaking point. That is another reason to worry about a bout of yen appreciation in 2018 (see Willem’s blog from last year for more details) as the Japanese currency becomes less and less correlated with US treasury yields.
However, the declining pace of Japanese asset purchases is also part of the global trend towards ‘quantitative tightening’ (QT) that we’ve highlighted as a major theme for 2018. It comes alongside the slowdown in bond buying from the European Central Bank and the outright reduction in the Federal Reserve’s investment portfolio.
Does this mean we should be worried about the potential disruption to global risk assets from the Bank of Japan slowing its asset purchases?
Here, I think the evidence is much less clear. It’s a nice narrative that Bank of Japan asset purchases have forced Japanese investors into increasingly risky assets overseas. But, the data suggest something very different is going on.
In Europe, the introduction of negative interest rates and central bank asset purchases has driven large purchases of overseas debt (see the left-hand chart below). On a net basis, Europeans have bought €600 billion (c. US$700 billion) worth of foreign debt securities over the last twelve months.
In Japan, the same policy catalysed a brief foreign bond-buying spree, but it has since completely unwound (see the right-hand chart above). Given that net flows from Japan to the rest of the world have not been catalysed by QQEWYCC, it is really unclear why unwinding the policy should have a big impact in the opposite direction.
In conclusion, the Bank of Japan is trying to convince the market that there is “nothing to see here” despite a sharp drop in its asset purchase flow. Add this to the list of reasons to worry about potential yen appreciation but don’t think of it as a leading concern for global rates or risk assets. After the last few days, there are enough of those to go around already.