TOKYO – Judging by the dearth of volatility in yen trading, investors aren’t expecting fireworks from the Bank of Japan tomorrow (April 28).
Surprises do happen at BOJ headquarters, of course. But this being Kazuo Ueda’s first policy meeting as governor, the odds are low that Tokyo is about to shock global markets with an about-face in its 20-plus-year experiment with quantitative easing.
That would be wise considering the worrisome mix of troubles bubbling up under the surface of the world’s third-biggest economy. Those include worries about a Silicon Valley Bank-like blowup among Japan’s 100-plus regional lenders.
Another: the high likelihood of political blowback in Tokyo if Ueda made radical monetary policy moves right out of the gate.
This latter point is often underappreciated in analyses of the BOJ’s latitude to take risky steps. Though “independent,” the BOJ in reality is on a shorter leash than many observers like to admit. Case in point: Haruhiko Kuroda leaving the BOJ governorship earlier this month with zero effort to wind down QE.
Granted, the BOJ had already been deep in the QE matrix for 13 years by the time Kuroda arrived in 2013. But he turned Japan’s QE era up to 11 and then some. And with limited success, clearly, as wages flatlined amid record corporate profits compliments of a plunging yen.
Still, the big gains in Nikkei stocks and relative macroeconomic stability earned Kuroda considerable political capital at home. Capital he could’ve spent on his way out the door plotting ways to reduce the BOJ’s US$5 trillion balance sheet.
Kuroda didn’t, leaving Ueda with what’s arguably the worst job in global economics. As Ueda presides over his first policy deliberation as governor, memories of December 20, 2022 loom large.
On that day, all hell broke loose in markets after Team Kuroda announced the slightest of tweaks to its “yield curve control” policy. The move to let 10-year bond yields rise as high as 0.5% was meant to limit the gap between US and Japanese interest rates. That, Kuroda figured, would reduce pressure on the BOJ to intervene in markets day after day.
The Kuroda BOJ spent the next two weeks cleaning up the move’s mess by making countless unscheduled asset purchases to reassure global investors that QE is here to stay.
Then came the Silicon Valley Bank crisis in the US. Next, UBS having to save Credit Suisse, which served to spike global paranoia levels to the next level.
Now, comes news this week that San Francisco-based First Republic Bank’s troubles are far from over. And, it follows, concerns about new US bank failures are intensifying by the day.
This is the limited option environment into which Ueda steps. Reports from Bloomberg that US regulators may downgrade First Republic’s prospects are making headlines just as Ueda sits down to mull BOJ policy. It’s worth noting, too, that Japan’s economic performance thus far in 2023 has not been stellar.
“Although the recent decline in government bond yields might seem to open the door for tweaks to yield-curve control, such a step could backfire,” says economist Stefan Angrick at Moody’s Analytics. “Economic data of late haven’t been good. Disappointing GDP growth means the economy is still smaller than before the pandemic. Employment conditions are showing signs of softening, and wage growth is trailing inflation.”
Complicating matters, recent “shunto” wage negotiations yielded the biggest wage gains since 1993 – an average 3.8%. Trouble is, coming amidst the highest inflation in 40 years, the timing of the pay bump could fan overheating risks. Here, China’s rebound adds to the risk of global inflation getting a second wind.
As Angrick notes, “notwithstanding a strong shunto spring wage round, it is unclear that this year’s gains will be repeated next year. Recent financial market disruptions abroad have only added risk. Given the BoJ’s history of premature policy tightening, the bungled yield curve control tweak in December, and the cold water poured on the idea of a change at the first press conference with the BOJ’s new leadership, it is unlikely the BOJ will move soon.”
The reference here to wage uncertainties for next year deepens the plot for Ueda. On the one hand, the new governor doesn’t want to let inflation become even hotter. On the other, Tokyo’s political establishment would pounce if BOJ “tapering” spooked CEOs into closing their wallets anew.
As Naoko Tochibayashi, a World Economic Forum analyst in Tokyo, notes, even now “it remains to be seen if similar wage rises can be seen in small and medium-size enterprises, which make up 70% of employers and are key to Japan’s economic revival.”
This dramatizes the precarious balancing act Ueda faces. So does the fragile state of Japan’s regional bank network. Many of these lenders service rapidly aging communities in already sparsely populated areas of the country. That squeezed profits well before the banking shocks of the last 15 years, including fallout from the 2008 “Lehman shock.”
That episode, graying customer bases and an accelerating exodus of companies to Tokyo had regional banks hoarding government and corporate bonds instead of lending BOJ liquidity. It was a similar practice that blew up SVB and New York-based Signature Bank.
As of the end of December, SMBC Nikko Securities estimated that regional lenders were sitting on about $10.5 billion of unrealized losses on foreign bonds and other securities. Such figures raise a difficult question Ueda now has to answer: how big might losses get on domestic debt if Japanese government bond yields rose above, say, 1% or more?
The good news is that many Japanese banks tend to prioritize bonds that can be sold rather than holding to maturity SVB-style. As such, SMBC Nikko analyst Masahiko Sato reckons the threat to capital ratios, on average, is only about 2%. Therefore, Sato does “not think potential losses are on a scale with systemic implications.”
BOJ tapering or even a rate hike or two could change this calculus, and fast. If regional banks face profit pressures with rates at zero – and the BOJ is still in 24/7 ATM mode – just imagine the valuation losses if Ueda were to hit the monetary brakes.
Yet Ueda’s pedigree suggests he could be more of an out-of-the-box thinker than currency strategists grasp.
During his time as a BOJ board member in 2000, Ueda dissented on a move to end the zero-rate strategy. His background as a Massachusetts Institute of Technology-trained economist, meanwhile, could be its own wildcard.
At MIT, Ueda was a pupil of Stanley Fischer, a former senior official at the Fed, the Bank of Israel and the International Monetary Fund. Fisher also taught former Fed chief Ben Bernanke, former European Central Bank head Mario Draghi and former Treasury Secretary Lawrence Summers.
Other members of the MIT monetary club: Reserve Bank of Australia Governor Philip Lowe and former Bank of England governor Mervyn King.
In February, Summers called Ueda “Japan’s Ben Bernanke.” Ueda and Bernanke, it’s worth noting, made their economic reputations exploring the lessons from the Great Depression, including Japan’s late-1920s to mid-1930s policies.
For Ueda, that entailed a keen focus on the 1930s policies of Korekiyo Takahashi, who’s often called the John Maynard Keynes of Japan.
Takahashi served as finance minister, BOJ governor and even prime minister in the 1920s and 1930s. His super-aggressive monetary easing, fiscal expansion and “debt monetization” efforts were as pioneering as economic policy gets.
There’s also reason to think Ueda could be a rather conventional central banker. He’s said so far, for example, that there’s no urgency to alter the BOJ-government framework that mandates the central bank target 2% inflation.
“If needed, Ueda likely will request the government to revise the joint statement so that the BOJ can respond flexibly, without sticking with the continuation of monetary easing,” says JPMorgan Chase & Co economist Benjamin Shatil. “We continue to see an exit from yield-curve control in coming months.”
Yet odds are decidedly low that Ueda would choose tomorrow (April 27) to toss financial explosives into jittery markets. And that seems wise for now.
Follow William Pesek on Twitter at @WilliamPesek