Recap 2014-10-31: Thoughts on Japan

Commentary:

About the BoJ Action –

Things that made sense:

• Inflation (ex-VAT hike) was slowing even before the drop in oil prices, and the BoJ was likely to miss its inflation target within its original time frame. To additional easing at some point to achieve their goals is warranted
• Having the GPIF switch asset allocations from JGBs to stocks shortly after the BoJ announcement enhanced the impact. It also gives the impression that the GPIF shifts could be part of the policy tool kit in the future (Although Kuroda denied that the announcement of the BoJ and the GPIF was concerted action)
• Shock & Awe may keep inflation expectations from falling too far in the future

Things that didn’t make sense:

• The open ended nature of the program only has credibility if the markets believe that the BoJ will actually be willing to continue it forever if necessary. However, with a 5-4 vote, (the first such split vote in BoJ history!) this is clearly not guaranteed. What will happen once Kuroda (70y old) retires or steps down? What if the next board member replacement is hawkish?
• Noting the drop in oil prices as a rationale for easing. Central Banks can’t affect oil prices, and their impact on headline inflation is temporary. That’s why the Fed ignored the drop in oil prices in their last statement. Their note of a return to a ‘deflationary mindset’ is also a red herring – inflation breakevens and surveys all continue to show positive inflation expectations. Brent priced in JPY is down 17% YTD.
• The BoJ is already having trouble buying short term JGBs. (i.e. not enough sellers) In other words, clearly the JGB market mechanisms have been affected. There is a rising risk that interest rates no longer reflect long term market expectations for the economy.
• The (apparent) plan to hike sales taxes down the road as scheduled. The whole point of QE is to finance fiscal expenditures. Why even do QE if they are going to tighten fiscally?!?

Clearly, asset prices, especially Yen denominated, moved massively today. So on its face, it appears the BoJ policy had a major effect. BUT the official change in the GPIF allocation is also massive, and a surprise. With an AUM of 127trn, the change in asset allocation implies a net sale of 16.5trn Yen to buy foreign currencies and assets. In USD terms, that’s roughly 150bn. In addition, the GPIF will sell 10trn Yen, or 88bn USD, of JGB’s to buy Japanese stocks. Those are massive amounts, (and if we include 3 mutual aid funds that use the same target allocations as the GPIF, the net amounts increase by ~20%) and the announcement would’ve moved markets substantially on its own. As a result, it’s not clear how much of the move in asset prices were driven by the BoJ, and how much by the GPIF announcement. This question is key – because the BoJ can print forever, but the GPIF can only rebalance like this one more time.

		Old Pct	Old Amt		New Pct	New Amt		Change	In USD
AUM (bn)		100%	127,263		100%	127,263		0	0
Domestic Stocks		17%	21,966		25%	31,816		9,850	88
Domestic Bonds		53%	67,908		35%	44,542		(23,365)	(209)
Foreign Stocks		16%	20,337		25%	31,816		11,479	102
Foreign Bonds		11%	14,075		15%	19,089		5,014	45
Short Term Assets		2%	2,978		0%	0		(2,978)	(27)

It’s also interesting to note that JGB yields barely moved on the news. 10y JGB’s yields declined by just 1.1bps today, to 45.8bps from 46.9bps prev. 30y JGB’s declined a tad more, by 5bps to 1.604%. This may be because the 30trn increase in BoJ purchases of JGB’s will be offset by the expected GPIF sale of 23.4 trn JGBs this year. But given that the BoJ purchases will be ongoing, and with a longer maturity target, while the GPIF asset reallocation is a one time event, the BoJ purchase effect should dominate. Another way to see it is that over the next 12 months, the GPIF will be selling JGB’s to the BoJ, and using the proceeds to buy stocks & foreign bonds. With respect to the BoJ purchases of ETFs, the 3trn pace (~18bn USD) is equivalent to 79bps of the JPX-Nikkei 400 market cap per year. In aggregate, the BoJ balance sheet will be ~70% of GDP by the end of 2015, and rising by ~15% of GDP annually.

The take away is that today’s policy change seem designed to affect expectations & sentiment rather than the real economy, given that nominal interest rates, inflation expectations, and real interest rates were broadly unchanged. The depreciation of the Yen is supportive, but it is not necessarily an obvious positive for Japan, given that several surveys this year have shown that businesses (not just exporters) are against significant further depreciation. In addition, the coordination between the BoJ and GPIF was clearly intended to be equity positive and yen negative – but this cannot be repeated more than once, as another 20% drop in JGB weighting would take it to just 15%.

If Abe does hike taxes as the consensus seem to believe, arguably the net effect for the real economy would be negative, and potentially quite negative. Once that is apparent, more BoJ easing seems likely.

Separately, per Chad Gassaway, today would be the 12th consecutive day of higher lows. Historically, a month later the S&P has been 2.03% higher on average and was higher eleven of thirteen times. Two months later the S&P was higher by 4.08% with a staggering 92.31% win rate (only one was lower). Finally three months later the market was higher by an average of 4.81% with a 84.62% win rate.

Notable:

• BoJ raised its monetary base target to 80T JPY vs prior 60-70T, vote was 5-4 for expanding. They extended JGB Duration to 7-10 years (from 6-8yrs) and tripled ETF and REIT Purchases (3T, 90B JPY per year respectively, a tripling vs the historical pace). BOJ Gov Kuroda post rate decision press conference stated that today’s expanded easing to would help it ensure to reach its 2%inflation target and saw room for more policy action if needed. The BoJ cut its CPI forecast for F2015 for the first time since the current program started, to +1.7% from +1.9%. They left core CPI outlook for FY2016 unchanged at +2.1%
• GPIF announced the new target weights:

1. Domestic stocks: 12% -> 25% (+/- 9% band).
2. Domestic bonds: 60% -> 35% (+/- 10% band).
3. Foreign stocks: 12% -> 25% (+/- 8% band).
4. Foreign bonds: 11% -> 15% (+/- 4% band)
5. Key Assumptions Include: Instead of a long-term equilibrium rate, domestic bond return is based upon a scenario that interest rates are expected to rise for 10 years

Japan Unemployment rose to 3.6% as exp vs 3.5% prev

CPI declined to 3.0% as exp vs 3.1% prev. The core measure was stable at 2.3% vs 2.2% prev

Japan Housing Starts dropped -14.3% YoY vs -17.2% exp and -12.5% prev

Chicago PMI jumped to 66.2 vs 60 exp and 60.5 prev

US UMichigan Confidence improved to 86.9 vs 84.6 exp and prev. Inflation expectations did not change much.

US Personal income rose 0.2% vs 0.3% exp and prev

Core PCE was stable at 1.5 as exp

UK Cons Confidence declined to -2 vs -1 exp and prev

EU Unemployment was stable at 11.5% as exp

EU CPI rose to 0.4% as exp vs 0.3% prev. However, the core measure declined to 0.7% vs 0.8% exp and prev

Canada GDP declined to 2.2% vs 2.3% exp and 2.5% prev

NZ Building Permits dropped -12.2% MoM vs +1.0% exp and 0.0% prev

Russia Agrees to Terms With Ukraine for Gas Supply to Resume: Negotiations brokered by EU, come as pro-Russia rebels are stepping up attacks on Kiev govt forces.

Upcoming:

• Weekend: AustraliaMfg PMI, Australia Building Approvals, China Non-Mfg PMI,
• Mon: EU PMI, CanadaPMI, US ISM, Australia Trade Balance, Retails Sales, RBA, Japan PMI
• Tue: EU PPI, NZ Employment, China HSBC PMI, Kuroda Speaks, US Mid-term Elections
• Wed: EU PMI, UK PMI, EU Retail Sales, US ADP, ISM Non-Mfg, DOE Oil Inventories, AU Employment, Japan PMI
• Thu: BoE, ECB, CanadaBuilding Permits, US Jobless Claims, Unit Labor Costs
• Fri: German Trade Balance, US Employment, Canada Employment, Yellen Speaks