The central bank is trapped in a position where it can’t easily extract itself from the equities market
By William Pesek –
Investors are betting big on Japanese stocks. Well, at least one: the nation’s central bank.
Overseas punters couldn’t seem to sell yen-denominated shares fast enough in the fiscal year ending March 31. In fact, they dumped them by the largest margin in 31 years – US$50 billion. That has the Bank of Japan gorging on stocks via exchange-traded funds – by roughly that same exact amount.
The plot thickens when you consider that in 2018, the BOJ’s balance sheet surpassed the entire size of Japan’s $4.9 trillion GDP. First, Governor Haruhiko Kuroda’s team cornered Japan’s government bond market, hoarding more than half of all outstanding securities. Now it’s bigfooting equities. Welcome to what’s arguably the world’s biggest hedge fund.
Yet the BOJ’s trading has now officially become one-way. Six months ago, Japan bulls were wagering that the BOJ would be “tapering,” or stepping back from history’s most aggressive monetary-easing experiment. US President Donald Trump’s trade war turned that into a losing trade.
Domestically, Japan isn’t just grappling with a possible recession, but two elections are coming as well. In April, voters will pick municipal leaders. In July, upper house lawmakers will be on the ballot. The last thing Prime Minister Shinzo Abe needs is a deepening slowdown that slams his Liberal Democratic Party’s prospects.
The same goes for Kuroda who, after six years on the job, is nowhere near his 2% inflation target. That essentially traps the BOJ. Reduce bond purchases and yields surge, further crimping business and consumer demand. Cut back on ETFs and the Topix stock index craters. Even after $50 billion of central bank largess, the Topix is down nearly 4% over the last 12 months.
The lesson for central banks everywhere is that pushing your tentacles into myriad asset classes is one thing. Exiting it quite another. Kuroda has started every year since 2015 with grand plans to end the BOJ’s official 80 trillion yen of annual bond purchases (US$716 billion) and reduce stakes in other debt arenas.
Ditto for curtailing support for the stock market. There’s something unsightly about the central bank of a developed economy being the main equity holder. China, perhaps. Group of Seven member Japan, not so much.
It’s also worth noting why foreign punters are beating a retreat from Japan. Trump’s trade war may be directed at China, but Abe’s Japan is taking some of the biggest hits. For all the chatter about structural reform, Abe has made few strides since 2012 to reduce Tokyo’s exposure to exports.
Overseas shipments from Japan fell 1.2% year-on-year in February, the third straight monthly decline. The January plunge, it’s worth noting, was a stock-market-shaking 8.4%. The BOJ’s quarterly tankan survey of big manufacturers fell the most in six years in March. Nor has the closely-watched barometer improved at all since late 2017.
One takeaway is that the stimulative effects of the yen’s 30% drop over the last six years are wearing off. The trade war, meanwhile, is slamming confidence on all fronts – among consumers, businesses and investors. So are concerns about Tokyo entering into bilateral trade talks with Trump’s White House. Those discussions, Abe’s team fears, will include demands that Japan accepts a stronger exchange rate.
That will pit the BOJ against the Federal Reserve, which is under intensifying attack by Trump’s White House. Along with calling the Fed “crazy,” Trump is demanding that Governor Jerome Powell cut short-term rates by 50 basis points. Any move by Kuroda to add additional stimulus to safeguard the economy is sure to irk Trump, putting Japan even more so in harm’s way.
Can Japan ever withdraw from markets? It will be years until we know for sure. If Team Abe had done more to reform labor markets, incentivize innovation or cut red tape, the BOJ could plot a course away from the nationalization of markets. Barring bold structural changes, the Kuroda Partners LP hedge fund will be stuck buying Japanese bonds and stocks indefinitely.