Before discussing the BOJ’s recent actions, consider the following, which demonstrates the aggressive use of monetary policy by the BOJ:
- The BOJ cut their equivalent of the Fed Funds rate to zero in 1999 and, excluding a few minor variations, it has stayed at or below zero since then.
- The BOJ buys and owns Japanese Treasury bonds (JGB’s), ETF’s and REITs.
- The BOJ owns 48% of outstanding Japanese Government Bonds (JGBs)
- The BOJ is a top-ten shareholder in over 40% of Japan’s listed companies.
- The BOJ owns nearly 80% of domestic ETF’s.
- The BOJ’s balance sheet is over 110% of Japan’s GDP, dwarfing the Fed (21%) and the ECB (24%).
Throughout the summer of 2016, rapidly rising interest rates became a concern for the BOJ. We say that tongue in cheek as ten-year JGB yields only rose about 0.30% over a few months and were still negative. A continuation of that trend was clearly a threat to the BOJ and, in September that year, they took decisive action to stop the assent of yields.
As discussed in the opening statement, QQE with yield control and the new inflation overshooting commitment would provide the BOJ with unlimited abilities to fight rising rates. Included with that policy modification was a limit or cap on ten-year yields at 0.10%. If that yield level were breached, they would throw the proverbial kitchen sink at the market to fight it. The graph below shows ten-year JGB yields and the effectiveness of the cap (red line).
The BOJ owns an overwhelming majority of Japanese stocks and government bonds. Their control is significantly greater when you consider their ownership of the true float of the securities. This is incredibly important to grasp as the BOJ is quickly reaching the limit on how many more of those assets it can buy.
That is not to say that they don’t have options once they buy all the bonds and stocks the capital markets have to offer. The options become more extreme and, quite frankly, much more consequential. For example, they could take the route of the Swiss Central Bank and buy foreign stocks. They could also print money and give it directly to citizens, aka helicopter money. Both options have grave implications for their currency and greatly increase the odds of meaningful instabilities like hyperinflation.
The BOJ’s rationale for allowing greater flexibility is to address “uncertainties” related to the anticipated consumption tax hike in 2019. In our opinion, the flexibility is the BOJ’s way of whispering “Uncle”. They know they are limited in their ability to further manipulate interest rates and stock prices and do not want to tip their hand to the market. Again, if the market senses the BOJ’s toolbox is empty, trust and confidence could fade quickly.
Some may say this is a first step in the BOJ taking their foot off the monetary gas pedal, and if so, we welcome and applaud such action. What seems more likely is that the market has finally sensed the BOJ’s Achilles Heel.
Summary
Public trust and confidence is the single most important asset a central banker can possess. Without these, they are printing worthless currency and have little to no power.
Shorting Japanese bonds has been called the “widow makers trade” as one must have incredible patience and plenty of time to outlast the BOJ’s will. Thus far, anyone that has fought the BOJ has lost, hence the nickname. Japan’s problems have been brewing for decades, and despite recent signs that the BOJ is running out of weapons, we would remain reluctant to fight them.
Of greater concern to us is the macro picture that is emerging in Japan. If investors are starting to question the on-going ability of the BOJ to manage rates, it is not unreasonable to think that other central banks could be at risk. While this story will continue to play out over a long time frame, markets seem content to ignore the growing problem. Our concern is that, if you are not prepared to act when the market unexpectedly awakens, you will be the victim of the reversal of years of interest rate price controls and asset price manipulation.
Keep in mind; you can’t buy homeowners insurance once the house is on fire.
Authored by Michael Lebowitz via RealInvestmentAdvice.com,
