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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
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Head of Fixed Income Strategy
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Macro Insights: Bank of Japan’s new governor Ueda – continuity with flexibility
Charu Chanana
Chief Investment Strategist
Summary: The policy stance of Bank of Japan’s governor nominee Kazuo Ueda, became much clearer with the parliamentary hearings kicking off today. He assured continuity of the current easy monetary policy with a steadfast focus on achieving 2% inflation sustainably. However he was cognizant of the side effects of yield curve control, and flexible to responding to market pressures with tweaks as needed. This comes against market’s strong anticipation of a hawkish tilt.
The highly awaited event of the week was the parliamentary hearing of new Bank of Japan governor nominee Kazuo Ueda in the lower house. That went ahead without creating much sparks, with Ueda broadly sticking to the outgoing Governor Kuroda’s script initially, but later qualifying that with remarks that suggested he will remain flexible and open to policy normalization.
As we highlighted earlier, Ueda has been out of touch with BOJ policy making since 2005 and will likely take it slow to even consider policy normalization at some stage. His neutral comments today, coming against market’s hawkish expectations and together with the rising global yields, suggest yen could embark on a weakening trend again once we are past this volatility. Japanese equities have responded positively, and continue to look promising.
Inflation goal unlikely to be changed
Markets have continued to believe that PM Kishida’s choice for the next BOJ governor to be someone from outside the bank or the Ministry of Finance has meant that people from within the circles didn’t want the job. This has reaffirmed the view that policy is moving towards an exit and boosted expectations that the joint statement from Ueda and the government could alter the 2% inflation goal.
That seems unlikely for now. Ueda’s comments clearly echoed Kuroda-san’s view that the current inflationary pressures in Japan are import-driven and unsustainable. While he continued to emphasise the importance of wage growth, he also said that a number of factors will be key to determine price pressures and it will take time to achieve the 2% target in a sustainable and stable manner.
As such he continued to emphasize that the key goal for the BOJ is to achieve the 2% inflation sustainably, while fiscal policy can be used to mitigate supply-side sources of inflation.
Policy tweaks rather than normalization
Ueda was not as closed to considering policy normalization as Kuroda. He said that it is his responsibility to ensure that normalization is carried out at the right time if the 2% inflation goal is reached. This means if inflation proves sticky, then the review of the yield curve control is now more likely that it ever was under Kuroda.
However, given Ueda’s view that inflationary pressures are currently unsustainable, normalization remains unlikely for now. Ueda still accepted that there are side effects of yield curve control, and remained open to considering policy tweaks.
What tweaks may be considered?
Ueda stopped short of hinting at just what policy tweaks may be considered, but he remained open to considering tweaks like shortening the long-term interest rate target to 5-year or 7-year from 10-year currently, or even widening the band. This was a contrast to his comment ten days back, where he stated that gradually raising the ceiling creates waves of speculation as market participants just position for the next yield target.
While expectations of an abrupt exit may have cooled, market’s hawkish expectations can continue.
Other options to embark on policy normalization if inflation proves more than transitory will be ‘creative’. He hinted at moves such as raising interest rates on financial institutions' reserves parked with the central bank rather than selling bonds.
Communication with the markets
Markets can however expect somewhat improved communication from Ueda, both domestically but also in terms of coordination with foreign central banks which will be key if the YCC policy is abandoned at some point in the next 5 years given its massive global implications. This should reduce speculative positions and bring the safe haven status of yen back in focus.
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