TOKYO – Rumors that Bank of Japan “tapering” will wreck China’s 2023 – or Asia’s trajectory more broadly – seem greatly exaggerated as the Japanese government leans toward naming a dovish central-bank head.
News that deputy governor Masayoshi Amamiya is favored to replace the retiring Haruhiko Kuroda is already sending the yen lower. It belies speculation that Prime Minister Fumio Kishida would name a BOJ head to plot an exit from 20-plus years of quantitative easing (QE).
It’s well understood that the next BOJ leader come April faces the near-impossible task of normalizing ultra-loose monetary policies. This liquidity became the fuel supporting Japanese gross domestic product and markets – and part of Japan’s financial filament.
“We think the risk of a major change in the BOJ’s reaction function immediately from April 2023 would decline” if Amamiya gets the job, says economist Takeshi Yamaguchi at Morgan Stanley MUFG. “While the government’s choice of Amamiya-san would not be a surprise, the market would likely perceive him as the most dovish or the least hawkish among the candidates whose names have surfaced.”
Economist Toru Suehiro at Daiwa Securities adds that “the chances of rejecting current policy have become slim. While the scrapping of yield curve control is possible once the stabilization of the bond market is confirmed, a clear rate-hike move like ending the negative rate seems unlikely.”
December 20 now seems like a long time ago. That’s when Kuroda’s team let 10-year bond yields rise to 0.5%, double the previous upper limit. It was read as evidence that tighter BOJ policy is on the way. Such a U-turn would wreak havoc with China’s 2023.
Sharp yen gyrations tend to pull the rug out from under the global financial system. Since the mid-1980s, history is replete with examples of sharp yen moves spooking asset markets everywhere. This risk has grown exponentially since the late 1990s, when the BOJ pioneered QE.
Since then, Japan has become the biggest creditor nation. Borrowing cheaply in Tokyo and moving those funds into higher-yielding markets around the globe – the so-called “yen-carry trade” – became the strategy of choice for global hedge funds. Now that it seems the BOJ will be largely staying the QE course, officials at the People’s Bank of China, the Bank of Korea and monetary authorities in Southeast Asia can breathe easier.
Japan too, at least in the short run. Yet after more than 23 years of QE and 10 years of commandeering government bonds and stocks, the BOJ will have to muster great courage to throttle back, never mind reversing itself.
Kuroda demurred in his last several months at the helm. Over 10 years holding the controls, Kuroda built unprecedented clout in Japanese political circles. He could have used it to set the stage for his successor to begin withdrawing from bond and stock markets – and an eventual rate increase or two. Kuroda could have done so by announcing plans to end QE and offering a rough timeline.
One reason Kuroda didn’t: fear of pushing Japan into recession at a moment when Kishida’s approval numbers are in the mid-20s. Another: as the biggest holder of government bonds and Tokyo stocks, the BOJ would be on the hook for epic losses as assets plunge. In November, the BOJ booked its first ever unrealized loss. It was in the red to the tune of US$6.3 billion on its government bond holdings in the six months to September.
After taking the reins in March 2013, Kuroda supersized the BOJ’s balance sheet in fateful ways. By 2018, it topped the size of Japan’s entire $5 trillion economy. That remains a first for a Group of Seven nation.
Yet Kuroda’s monetary “bazooka” blasts, as traders called them, didn’t end Japan’s 20-year battle with inflation. Russia’s Ukraine invasion did. Since Vladimir Putin’s army moved against Kiev 12 months ago, energy and food prices have posted record increases. That, on top of Covid-19-related supply-chain distortions, left Japan with its fastest inflation increases in 40 years.
The key for Amamiya might be to persuade lawmakers to give the BOJ a new target. Rather than 2% inflation, Japan might get greater traction directing the policymakers to target a 2% wage gain per annum or some amount of annual increase in the GDP.
Despite Japan’s inflation spurt, wages remain largely stagnant – a pattern that has been playing out for more than two decades now. That means that if inflation rises and growth muddles along, Japan could now face stagflation.
As Kishida said last month: “The core of a virtuous economic cycle lies in wage growth and must be realized at all costs. Companies must generate profits and then properly distribute them to workers. Consumption will grow, business investment will grow and further promote economic growth.”
Only there’s little evidence this is even close to being realized. A central mistake Japan has made since the 1990s is concluding that deflation is its top challenge. Deflation, though, is a symptom of Japan’s multi-decade malaise, not the underlying cause.
If only Japanese lawmakers had listened to Kuroda’s predecessor, Masaaki Shirakawa. As his term drew to a close in 2013, Shirakawa warned that weak prices were the result of a fast-aging population and a lack of optimism about the future. As the nation grays, he argued, there’s naturally less demand for new homes, cars, appliances, fashion and travel.
The latter point relates to 22 years of governments – Kishida’s is the 10th since 2001 – promising Big Bang reforms and delivering minor tweaks here and there. Japan’s 126 million people have seen how this movie ends too many times to buy into a Kishida reboot.
These headwinds eventually overwhelmed the amount of yen in the financial system. The BOJ can certainly print more yen, but to what end?
Ten years ago, Kuroda promised to reverse the “deflationary mindset” impeding pricing power. Succeeding, though, required that lawmakers did their part to liberalize labor markets, reduce bureaucracy, alter tax incentives, incentivize innovation and productivity to give companies greater confidence to fatten paychecks. But it is also a product of treating the symptoms of deflation rather than the causes and a lack of policy audacity.
With sub-30% support rates, odds are Kishida will be too busy fighting to keep his job to do his job. That leaves little optimism that structural reforms will take the lead in driving Japanese growth.
Easy BOJ policy remains the only game in town. Economist Richard Katz notes that many observers and speculators think it’s just a matter of time before the markets push rates up again and the BOJ is forced to yield.
As Tokyo University economist Takatoshi Ito puts it: “Kuroda argues that the BOJ hasn’t started moving toward the exit. But the BOJ has already put its shoes and coat on.”
But “they’re wrong,” Katz argues. “This policy is sustainable and time is on the side of the current policy.”
Katz recommends looking “more closely under the hood of the latest inflation numbers. They’re not taking into account the volatility of prices for food and energy, which we must import. Prices for both categories are now going down globally, as we had expected.
“On top of that, with the yen now stronger than in November, we don’t need to pay as much in yen terms for our imports of food and energy as we did a couple of months ago. That puts more downward pressure on inflation.”
Others aren’t so convinced that Amamiya means the BOJ stays on autopilot. To economist Joseph Capurso at Commonwealth Bank of Australia, “it’s normal that a deputy would be considered for the top job. The news does not change our view that the BOJ will dump yield-curve control and negative interest rate policy by midyear if wage growth continues to pick up.”
Strategist Nicholas Smith at CLSA Japan notes that “upside pressure on rates is unrelenting and the BOJ will find it very hard to hold them at this level.”
The International Monetary Fund, Smith notes, suggests that Japan should raise the yield-curve control ceiling. At the end of December, meantime, Kuroda disclosed that BOJ losses on Japanese government bond holdings had ballooned to 8.8 trillion yen, or about $66 billion. “Further buying,” he says, “risks potential losses ballooning.”
Yet 20-plus years of free money is proving a hard habit for Japan Inc. to break. At the very least, rumors that the BOJ is about to shake up China’s 2023 in sudden and unpredictable ways seems greatly exaggerated.