The BOJ will be delivering it's latest policy decision tomorrow, and we don't expect any changes from them.
As we mentioned in our viewpoint posted on 25 May, the upside pressure in 10yr JGB yields has abated alongside UST yields (owing to the Trump political turmoil, scepticism of a 3rd Fed hike for 2017 amidst growing concerns of a more subdued US Q2 growth rebound), which negates the need to tweak the YCC targets (guiding s/t rates to -0.10%, targeting the 10yr yield around 0%) at this stage.
As mentioned back then, our expectation of the window opening up for a change in BOJ policy has been pushed back from Sep to Dec, which would bring it more or less in line with the end of the ECB's QE program, and we expect the BOJ will keenly follow the market reaction to the ECB's move as a template.
Market focus on any guidance shift
It would have been a pretty straight-forward non-event by way of an unchanged on-hold stance/dovish tone after the shocking miss in Japan's final Q1 GDP.
That said, things have been somewhat complicated after the recent bout of speculation surrounding the BOJ's forward guidance.
- Recall that BBG reported on 08 Jun that the BOJ will tweak it's guidance to acknowledge that it is considering QQE exit plans but at the same time stress that an exit remains some way off. According to BBG sources, BOJ members think that it's unrealistic to ignore the ongoing market chatter about QQE exit despite as yet subdued inflationary pressures, and that it could be more constructive to make clear that it's conducting internal simulations.
- The Sankei subsequently reported on 13 Jun that the BOJ won't be tweaking it's econ assessment this time around. In particular, the Sankei said that the BOJ will leave intact it's "moderate expansion" assessment with any upward revisions to come in Jul.
- Whilst the Sankei report was not a direct riposte to the BBG speculation, it has nonetheless tempered the market's expectations going into this meeting.
In essence, the dynamic within the BOJ is reminiscent of that within the ECB. Gov Kuroda will likely push back against hawkish leanings.
On balance, we do not expect a guidance shift this time around with any change more likely in either the Jul or Sep meetings.
There will likely be little meaningful market impact from the BOJ decision as such.
Looking further out, the balance of risk is tied to USD/JPY weakness which could frame the sentiment on the broader Yen complex.
For the 10yr JGB yield, we are still expecting it to consolidate around 0.047% for the time being.
- That said, 2-way risks btwn 0.015-075% abounds in accordance with it's UST counterpart.
- The interesting thing to note here is the implications of a further decline in UST yields as the market discounts a 3rd Fed hike for 2017.
- In this scenario, it could push the BOJ to cut it's JGB purchases which would extend the trend of quiet tapering seen over the past 2mths.
See below for our take on the BOJ's YCC.
For the 20s, we still expect it to mostly trend sideways btwn 0.520-605% in the n/t.
- Note that Tues' 20yr auction saw strong demand, bid-to-cover at 3.98 vs 3.84 at the 18 May auction.
- Beyond the lead from USTs, demand was also boosted by the fact that this 20yr issue is set to become the benchmark 20s.
- No change to our long-held view that there is inherent demand (both leveraged and real-money) in the back-end given re-investments from maturing debt.
We refer back to our 01 Jun viewpoint.
The BOJ will inherently be loath to cut purchases in the mid sector given any such move would jolt the market and push the 10yr yield significantly higher, which then brings back the spectre of an unlimited bond purchase operation last seen in early Feb. Recall the BOJ's rumoured line in the sand was the 10s pushing well above 0.100%.
What changes could be seen ahead? Possibly a cut in the 1-3yr purchases
- The BOJ will now need to factor in global risks. UST yields have been soft since the Trump political controversy started and subsequently compounded by weak US data. Gilt yields are on the backfoot amidst UK political uncertainty.
- As such, we see the possibility that the BOJ may well cut purchases in the front-end in Jul. Specifically, purchases in the 1-3yr segment could be cut by Yen10 bln.
YCC machination facilitates tapering that's gone under the radar
- We pointed out back in Sep 2016 when the BOJ shifted to a YCC strategy that because of how purchases would vary according to yield gyrations, there was a possibility of "tapering" if it needed to buy less (or sell) JGBs in order to counter a fall in yields outside of it's desired range.
- This YCC machination and the BOJ's reduced JGB purchases over the past 2mths has actually been a form of quiet tapering.
- Note how BOJ Kuroda pointed out previously on 10 May that their monetary base has been increasing at a Yen60 trln annual pace (much lower than the soft target of Yen80 trln annually), which was somewhat lost in translation on the day of his speech.
- Thus, contrary to the BOJ's insistence that it will ease further if needed, they are actually quietly tapering under the guise of YCC.
- Even if they were to increase the amt of purchases from here, it would merely bring them back to previous levels, which in the most arcane definition, isn't doing more. JH