BoJ Soon to Take Its Deflation Fight to Another Level

I believe Japan’s aggressive monetary policies will continue to reward those who invest in its stock market. To review, the first arrow of Japanese PM Shinzo Abe’s “three arrows” of economic policy, aggressive monetary easing, was implemented by BOJ governor Haruhiko Kuroda to eradicate Japan’s long-standing deflationary pressures. In April 2013, soon after Kuroda became Governor, the BOJ introduced “Qualitative and Quantitative Easing” (QQE) which has since been expanded. Currently, the BoJ is buying annually 80 trillion yen of JGBs, 90 billion yen of  JREITS, and 3.3 trillion yen of ETFs. The money printing has caused the Nikkei to rally by 45% and the yen to depreciate by 28% against the US dollar up to January of this year.

Nikkei Performance During 1st Arrow


On January 29th, the BOJ tried to provide additional monetary stimulus by applying negative interest rates to banks’ excess reserves so that banks would be motivated to lend. However, the move backfired as the Nikkei has fallen 4% since then while the S&P 500 rallied 9% and the yen strengthened by 8%. A likely explanation for this market reaction:

BofA noted that the policy of applying negative rates to banks’ excess reserves didn’t take effect until mid-February and trust banks began passing the cost on to fund management companies in mid-April. That spurred the management companies to pass the cost on to investors, which worked against the BOJ’s efforts to encourage portfolios to rebalance toward riskier assets, BofA noted.

Although, I am not certain that negative interest rates is such a couter-productive policy, the fact that the financial media has widely panned it will prevent central banks from moving further in that direction. As almost all central bankers believe, a prerequisite for a monetary measure being successful is confidence from the public that it will work. Given the market’s current aversion towards negative interest rates, the BoJ is unlikely to rely on it going forward.

Kuroda’s recent statement that the BOJ can still ease policy substantially, indicates that the BoJ is likely to lean on QQE going forward. I doubt that it will cause the yen to depreciate as it did during the past couple of years because, despite the BoJ’s massive money printing, Japan’s money supply growth lags the 5%+ growth seen in the US.

Japan M2 Growth

Conversely, the yen is unlikely to experience a major appreciation since the large number of speculators which have shorted the yen over the past 3 years have unwounded their positions. In fact, speculators are now net long the yen.

Yen SpeculatorsSource:

QQE could nonetheless boost equity valuations. I believe the BoJ will expand QQE this summer via increasing the rate of ETF purchases. At the current rate, the BOJ is running out of JGBs to buy and will own 50% of all outstanding government bonds by 2018. Also, the amount of current ETF buying ($3.3 trillion a year) pales in comparison to the 80 trillion yen of government bonds it purchases.

The increased demand for Japanese stocks resulting from BoJ buying, coupled with a low valuation of only 13.6x earnings could lead to decent though not spectacular returns. I have been long Japanese stocks while hedging yen depreciation; I intend to maintain the position, but will sell if there is a significant rally.

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