Japan's Policy Uncertainty Ends

Yesterday the Bank of Japan (BOJ) announced in a report “Strengthening the Framework for Continuous Powerful Monetary Easing” that its extraordinary policies will be maintained for an “extended period of time.” During the past week, rumors and speculation about possible monetary policy changes at this week’s BOJ meeting caused great uncertainty in Japan’s fixed-income market. Much of the confusion related to the BOJ’s yield curve control (YCC) policy, with commentators suggesting that greater flexibility may be allowed in the 10-year peg at 0.00%. On Friday, when some traders challenged the 0.100% upper limit of the peg, the BOJ was successful in defending it. The yield on the benchmark 10-year Japan government bond (JGB) closed at 0.095%. The BOJ purchased 94 billion yen of JGBs Friday, only the second time it has had to actually purchase bands in support of its YCC policy. Yesterday it returned to the market to again defend the 10-year peg.

Speculation about modifying the 10-year yield target related to a concern about the adverse effects of negative interest rates on bank profits. The BOJ announced several modest steps that address this issue, while making the current yield control policy more sustainable. The 10-year peg remains at 0.00% but the former +/- 10 bp upper and lower limits have been doubled to +/-20 bp. Also, a smaller part of bank deposits at the BOJ will be subject to a negative rate.

As was widely anticipated, the BOJ also changed the balance in its US$54-billion ETF purchasing program. It has been buying ETFs that are heavily weighted with stocks listed in the Nikkei index. As a result, the BOJ’s positions in some of those stocks are very high. In the future the BOJ will be shifting more of its ETF purchases to ETFs focused on stocks listed in the TOPIX Index.

The BOJ therefore, has made it clear that it is not gradually ending its highly accommodative monetary policies, in contrast to the forward guidance statements of the U.S. Federal Reserve Board and the European Central Bank. The yen eased to its lowest level since July 20.

The concerns in recent months about the future of Prime Minister Shinzo Abe and his “Abenomics” policies have lessened. Abe now appears to have the necessary support to secure a third term in the September leadership election of his party, the LDP, with the opposition parties too weak to offer a serious challenge. The broad outline of current economic policies is expected to remain on course.

The Japanese economy’s performance remains solid, but there have been some indications that momentum is slowing. The BOJ has reduced its inflation forecasts, projecting inflation in 2020 will be at 1.6%, still well below the 2.0% target. The Japan Purchasing Managers’ Index for manufacturing fell from 53.0 in June to a 20-month low of 51.6 in July, probably reflecting in part the effects of heavy rains and flooding. Slowing demand is seen as worrying. Japanese export demand was reported to have deteriorated despite yen depreciation and continued robust global growth. Future export performance depends very much on US-Japan and also US-China trade negotiations.

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Japanese equities have held up relatively well despite the negative trends affecting global equity markets other than that of the US thus far this year. While the benchmark iShares MSCI ACWI EX US ETF, (NASDAQ:ACWX), is down 2.86% year-to-date, the iShares MSCI Japan ETF, (NYSE:EWJ), is down just -1.59%. We are maintaining our Japanese positions in our International and Global Portfolios while monitoring closely developments on the trade front.

Written By: Cumberland Advisors