Is The BOJ About To Overhaul Its Entire QE Program: Wall Street's Take On The "Comprehensive Assessment" Clause

As previously reported, the yen soared more than 2.4% in an extremely volatile session, and the Nikkei plunged then soared, completing a stunning 1,000 point move, after BOJ’s stimulus disappointed watchers and failed to match expectations, with just an increase in ETF purchases and a doubling of a dollar-lending program to $24b.

The summary

  • Kuroda expands ETF target purchases to 6t yen, and orders assessment of effectiveness of BOJ policy for Sept. meeting
  • The BOJ maintained policy interest rate at -0.1%
  • USD/JPY just under 2% to 103.30 after falling as low as 102.71. Yield on 10-year JGB jumps 9.5 bps to -0.18%, set for the steepest advance since 2013
  • USD/JPY 3-mo. basis swap climbs 5.6 bps to -65 bps
  • Macro accounts sold USD/JPY after a muted rally following BOJ’s decision, with some clients already expecting BOJ to disappoint beforehand, trader says

For those confused by the unexpected letdown by the BOJ, here is a summary of Wall Street reactions to the central bank's announcement, courtesy of Bloomberg

Jun Kato (fund manager, Shinkin Asset Management)

  • BOJ’s decision was at the minimum end of what investors were expecting, disappointing them
  • Decision leaves some room for further easing after seeing details of the economic stimulus package by PM Abe
  • USD/JPY will probably see profit-taking and move gradually toward 100

Sim Moh Siong (FX strategist, Bank of Singapore)

  • Outcome of BOJ meeting was a let-down. Onus now on fiscal stimulus to do the “heavy lifting” for the economy
  • Sees 103.40 as a key level for USD/JPY; a close below there today raises the risk of another test of 100 level in 1-2 months

Hideo Suzuki (chief manager of forex & financial products trading, Mitsubishi UFJ Trust and Banking)

  • BOJ refraining from deepening the negative interest rate is a “relief,” though the 2- and 5-year JGBs are seeing selling pressure as the market has priced in cut of 10 bps
  • The decision indicates that there are limited options left for the central bank
  • Yield curve may face bear-flattening pressure

Kit Juckes (global strategist, Societe Generale)

  • This is an opportunity missed
  • “Conditions for a policy move were far more propitious than in January. The message the BOJ is sending is not so much ‘whatever it takes’ as monetary policy’s pretty much played out.”
  • Nothing here to weaken the yen

Nizam Idris (FX and fixed-income strategy head, Macquarie Bank)

  • Asian currencies have been rather moribund lately and BOJ’s decision today isn’t going to change things very much
  • SGD has the highest correlation to JPY among Asian currencies in recent months. Likely to remain case for now

Nicholas Smith (CLSA strategist)

  • Lack of full-fledged monetary policy stimulus by BOJ shows Japan’s economy can’t be fixed by the central bank alone
  • Seems PM Abe’s surprise stimulus announcement was on expectations that BOJ Governor Kuroda may not be able to do much
  • Kuroda has disappointed markets, especially currency, yet again. ETF buying, doubling of U.S. dollar lending is good but way less then what was discounted
  • Abe needs to do more now with central bank chipping in later

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Deutsche Bank's Makoto Yamashita explains why there is "risk of oBOJ overhauling QE framework" as a potential nevative for JGBs

Risk of BOJ overhauling its monetary easing framework following "comprehensive assessment" is a potential negative for JGBs

The BOJ announced an Enhancement of Monetary Easing on July 29, almost doubling its ETF purchases from JPY3.3 trillion to JPY6 trillion and introducing new "measures to ensure smooth funding in foreign currencies by Japanese firms and financial institutions" by way of a response to "volatile developments (…) in the global financial markets". However, market hopes for a further lowering of the marginal (Tier 3) policy rate were confounded, and the BOJ also opted to leave the quantitative aspect of its easing framework unchanged. The initial market reaction has seen the JGB curve bear-flatten and the yen strengthen.

The BOJ concluded its statement by saying:

… with a view to achieving the price stability target of 2 percent at the earliest possible time, the Bank will conduct a comprehensive assessment of the developments in economic activity and prices under "QQE" and "QQE with a Negative Interest Rate" as well as these policy effects at the next MPM. The Chairman instructed the staff to prepare for deliberations at the next meeting.

Some might interpret the phrase "comprehensive assessment" as a signal that further monetary easing could be forthcoming in September, while others may envisage the commencement of an overhaul of the current monetary policy framework. We are unable to rule out the latter scenario, and see potential for the BOJ to cut the policy rate while shifting to a more flexible target range for JGB purchases with a view to making them more sustainable. Many market participants have already expressed concerns about the negative side effects of BOJ NIRP and doubts as to whether the central bank can continue to increase its JGB holdings by JPY80 trillion per year. That said, it is also quite  possible that the BOJ will simply opt for further easing under the current framework after completing its "comprehensive assessment". In any case, with QQE+NIRP having catalyzed such a dramatic bull-flattening of the yield curve, uncertainty as to whether the framework will be maintained in its current form could potentially be a negative for the JGB market.

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Finally a comprehensive analysis from Goldman's Naohiko Baba which also focuses on the BOJ's "comprehsnive assessment" claue

Increase in ETF purchases designed to support confidence

Governor Kuroda said that heightened uncertainty caused by Brexit and slowdown in emerging economies necessitated action to prevent deterioration in corporate and household confidence. The bank decided to step up ETF purchases in particular because this measure is believed to be the most effective to prop up confidence among the three dimensions of easing. He also noted that there is no issue with respect to price manipulation.

Political pressure denied; instead, synergies with economic policy emphasized

Prime Minister Abe had surprised the markets by announcing economic stimulus just before the MPM and several Cabinet members had also made comments urging monetary easing, but Governor Kuroda denied any impact on BOJ decision-making from political pressure. Instead, he emphasized the potential synergies to be captured through a mix of fiscal and monetary policies. The BOJ left the negative interest rate and JGB purchase program unchanged at the latest MPM, but Governor Kuroda underlined that these measures were playing a major role in preventing a crowding-out effect from fiscal spending.

Adverse side effects of policy tools refuted

Governor Kuroda clearly refuted that there were any adverse side effects from the negative interest rate, and stressed that positive effects were already evident even in the real economy. He struck a softer tone on quantitative expansion via JGB purchases compared with his advocacy of the negative interest rate, noting only that the bank would not underestimate the importance of this policy.

He also continued to fly the flag for the 2% price stability target, underlining that the upcoming comprehensive assessment would be conducted solely from the standpoint of achieving the 2% target at the earliest possible.

Our impressions of the above are as follows.

  • Although Governor Kuroda denied any political pressure, we believe the decision to increase ETF purchases may have been the result of the BOJ seeking to avoid taking no action at all, under the strong demand from the government for a fiscal/monetary policy mix. We think that the BOJ, keenly aware that its remaining options were limited, may actually have preferred to maintain its policy status quo, backed by positive macro factors in the form of postponement of the consumption tax hike and the government’s fiscal stimulus package.
  • We believe some in the market may be harboring expectations for the BOJ to withdraw the negative rate policy or reduce JGB purchases once its comprehensive assessment is complete. Our impression from Governor Kuroda’s press conference is that: (1) the announcement of a comprehensive assessment is essentially a means to keep market expectations alive while buying some time; (2) the BOJ may consider buying other new financial products, but this would likely raise question marks as to the viability of such a policy, given issues with market size/liquidity and selling incentives for financial institutions; and (3) via a process of elimination, we accordingly see ample possibility that the BOJ will at the bare minimum maintain each of its three dimensions of easing, and expand them as it sees fit.
  • With regard to the negative interest rate policy in particular, Governor Kuroda said that the comprehensive assessment would include an examination of how the earnings of financial institutions would be impacted by a recent flattening of the yield curve. How the BOJ interprets the results of its examination based on the latest Apr-Jun financial institutions' earnings, which will feel the full effects of the negative rate policy, could in our view prompt the BOJ to further advance the policy.
  • We will spend some time to build our views on what the comprehensive assessment means and how its outcome might affect the BOJ’s monetary policy management.