Preview: The Bank of Japan decision is all about the yield curve
The BOJ has said that it can do more easing in hree dimensions - quantity (JGB purchase amount), quality (types of risk assets to purchase) and negative rates. PIMCO doesn't think so.
One of the reasons that the Federal Reserve gets more attention is because their decision is largely binary: Either they hike or they don't.
The BOJ, on the other hand, is using the Sept 21 decision to completely rethink its easing programs and philosophies. That leaves a multitude of variables.
PIMCO took a close look at the decision today and highlighted some of the limitations of the current program.
- At the current ¥80 trillion pace of net increases per year, the central bank will own 48% of the JGBs outstanding a year from now
The problem with the other 52% is that banks and life insurances need to hold JGBs and the IMF estimates the practical limit will be hit sometime in 2017 or 2018.
- The ultra-flat yield curve has hit the point where it's counterproductive
"we think the extent to which extraordinarily low rates have stimulated new productive investments is highly questionable," they write.
The latest leaks from the BOJ suggest they've realized that +10-year yields have gotten too low and the pain for the financial sector doesn't outweigh the benefits of cheap borrowing.
The question that PIMCO hints at, but doesn't answer is: What is the most-stimulative yield curve? What is neutral? and what is restrictive?
The increasing thinking at the BOJ is that they can still bring down the front-end and out to 10 years but by leaving long rates higher (or pushing them up from here), it minimizes the side effects on the financial sector.
What about FX?
So what does that mean for the yen.
The market likes unconditional easing and if the BOJ says it will keep buying at 80 trillion yen and will focus more on the front end and less on the long end, that's probably going to be yen positive (i.e. USD/JPY negative).
It would diminish the Treasury yield advantage in +10 year bonds even if it does the opposite at the front end.
That could be mitigated by more ETF purchases or other factors. The BOJ definitely cares about perception and the yen but if the market sniffs a monetary policy limit -- like it did early this year -- then the yen could rip higher.