It had been much talked about before yesterday and had been widely anticipated, however the Bank of Japan’s decision to hike rates for the first time since 2007 has been a notable day for investment managers and strategists signalling the end to eight years of negative interest rates.
Investment strategists and economists have been reflecting on this latest news from Japan, about what it means for portfolio construction and asset allocation as well as the outlook for Japanese equities as follows:
First up is Peiqian Liu, Asia Economist at Fidelity International, commenting on the Bank of Japan’s decision to exit the Negative Interest Rate Policy (NIRP) by changing its short-term interest rate range from -0.1% to 0% to a new range of 0% to 0.1%:
What happened
“The Bank of Japan has made the decision to exit the Negative Interest Rate Policy (NIRP) by changing its short-term interest rate range from -0.1% to 0% to a new range of 0% to 0.1%. The BOJ has also ended its Yield Curve Control (YCC) and Qualitative and Quantitative Easing (QQE) including purchases of Exchange-Traded Funds (ETFs) and Japanese Real Estate Investment Trusts (J-REITs). The central bank will gradually reduce the purchase of corporate bonds and commercial paper with a target to wind down the operation in about a year. To address any potential rapid increase in long-term interest rates, the BOJ has committed to continue its purchases of Japanese Government Bonds (JGBs) at a similar scale as before.
Our interpretation
“The BOJ has adopted a cautious tone despite the series of policy normalisation. The statement showed commitment to maintain an easing bias by highlighting “accommodative financial conditions will be maintained for the time being”. The statement has highlighted risks on external developments as well as domestic consumption. Recent data has also suggested that the underlying growth momentum in private consumption are not yet showing solid momentum. The new policy setting still retained some degree of flexibility (e.g. maintaining the same pace of JGB purchases in April to June) to act nimbly based on the inflationary impulse while the BOJ awaits more evidence to confirm the more sustainable inflation dynamics.
“In Governor Ueda’s press conference, we think he sent two key messages to markets. First, he highlights uncertainty in the sustainability of inflation over the long run, noting that it is far from certain that Japan’s inflation will decisively reach 2% target; and second, he retains flexibility in the operational policy options. We believe the market will now focus more on BOJ’s forecasts of inflation in the April Outlook Report for more guidance on the future rate paths.
Outlook
“Given that the BOJ is adopting a neutral tone about further rate moves, we think the future policy decisions will be more dependent on the central bank’s outlook as well as the dynamics of inflation. We believe that the wage and prices virtuous cycle will likely be sustainable and that may imply a higher neutral rate for Japan. The BOJ may need to hike its policy rate further to adhere to the 2% price stability target if the wage price cycle gains momentum. We believe maintaining an appropriate pace of rate hikes will also be important to the Japanese yen as the yield gap with the US remains wide, especially when the Fed is poised to stay higher for longer. In the interim, we think the Ministry of Finance will likely verbally intervene if USDJPY remains persistently above 150 levels.
“The key data to watch will be the April Tankan survey on business sentiment and capital investment plans, as well as the BoJ’s branch managers’ meeting in April on updates on wage increases for SMEs. Subsequently the BoJ will release its new Outlook Report at the April policy meeting. The revision of inflation outlook from the BOJ will likely be a critical guidance to the future monetary policy outlook.
Asset Allocation views
“Fidelity Solutions & Multi Asset currently has a overweight view of Japanese equities. Economic surprises and earning revision are positive and business activities continue to recover in Japan. We maintain a neutral view on the yen because we see continued gradualist approach from the BOJ while the Fed rate cuts are pushed out further down the horizon.”
Lindsay James, investment strategist at Quilter Investors has also shared her analysis of what this change in policy in Japan will mean for investors commenting:
“With the Bank of Japan finally announcing its first rate hike in 17 years, the chapter has closed on an era that brought the world ultra-easy money and introduced quantitative easing (QE) to the vernacular, but also drove asset price inflation that has seen equity returns far exceed the upper bounds of their usual bandwidth since QE was first copied by the US in 2008. Good news of course for those invested, but also laying the groundwork for today’s problems of inequality.
“For investors in Japanese equities, who have enjoyed breakout returns of 21.95% in sterling terms in the 12 months to the end of February, this first rate hike shouldn’t be a cause for a concern. The Bank of Japan has assured the market that rates will continue to remain accommodative even as yield curve control – its process of systematically buying 10-year government bonds to keep yields capped at 1% – has been watered down to a pledge to buy bonds ‘as needed’. There is no signal that this is the first hike of many, particularly given disinflationary trends have returned in the past six months. However, with signs that wages are set to grow in excess of 5% in the year ahead the Bank of Japan is clearly keen to move forward with its normalisation of monetary policy, this era of ultra-low interest rates looks set for the history books.
“With the Federal Reserve and Bank of England due to update markets later this week following rate-setting meetings, we can expect quite a different tone. With inflation still the core focus of central banks, despite signals that investors are beginning to move on, it remains to be seen how markets will react if the Federal Reserve indicates that its ‘data dependent’ approach will mean investors must wait longer for rate cuts. The soft landing scenario, which has become a near consensus view, may well end up facing increasing challenge if it turns out that rather than three cuts by year end, investors will be getting virtually none. The Bank of England signalled confidence that inflation would fall to target or below in the coming months, so it must face up to the question of whether it is bold enough to move ahead of the Fed. While the data may be more supportive of this, the risk of weakening sterling, an inflationary action in itself, will be one factor it must weigh.”
Also commenting on the news from Japan, Nikko Asset Management Global Strategist and Managing Director Naomi Fink said:
“The “trial balloons” of media announcements in advance of today’s BOJ rate rise apparently did their job, as the end of Negative Interest rates, Yield Curve Control and ETF purchases were smoothly digested by markets – indeed, the BOJ had already embraced greater flexibility on YCC and has significantly decreased its ETF purchases well prior to the policy decision. Neither the yen nor the Nikkei showed extraordinary movements, and JGB 10-year yields so far remain contained below 80bps. In prior speeches (e.g. Uchida’s much talked-about speech on 8 February), the BOJ made clear that it was watching the market for signals that its policy moves were well-anticipated, and this watchfulness appears to have paid off. The 7-2 vote also showed the comfortable majority whereby the decision was made. Overall, it is one significant yet incremental step on the path back to “normal” interest rates.
“It is important to remember that shifting from negative to 0-10bp overnight rates means more that the BOJ can return to operating policy via short-term rates, instead of via a set of unconventional policy tools, and that these rates remain extremely accommodative. BOJ is signaling to markets to expect accommodation to remain, that although Japan is closer to the “virtuous circle” of reflation that includes household willingness to shoulder higher prices, the achievement of these conditions is not immediate. We are now in wait-and-see mode, particularly given “uncertainty” coming not only from Japan, but also from overseas economies. As such, there remains no immediate catalyst for BOJ to continue hiking – evidence of real income growth, ongoing productivity-enhancing investment and positive sentiment from corporates, recovery in domestic consumption remain to be seen before any next move, given reflation is happening in a manner conducive to withdrawing stimulus very deliberately. Also, we haven’t seen cash decisively leaving household balance sheets for more yield-bearing investments; so long as reflation remains intact, such a savings-to-investment move should be an eventual characteristic of Japan’s “virtuous circle”, helped along by the tax advantages afforded by January’s “new NISA” enhancements. This would be the type of signal for the BOJ to go proceed with further policy normalization.
“One thing to watch remains Japan’s current account, which has benefitted from ultra-low rates domestically even as central banks tightened elsewhere. The main contribution to Japan’s external surplus is now the income account, as one might expect from a country with lower rates than elsewhere in the world. This composition explains why the yen remains on the historically weak side. It remains to be seen whether the ramifications of the termination of the world’s last negative rate regime may be felt elsewhere. For now, with BOJ reluctant to signal further policy tightening, markets do not appear ready to give up on the “carry trade” just yet – immediately after the decision, the yen remained under pressure following the decision, one sign that it is still being used to purchase higher-yielding overseas assets.
“Logistically, this frees the BOJ up to focus its full energies on the Outlook on Economy and Prices next month, which we anticipate should underpin the BOJ’s decision to exit unconventional monetary policy yet may also draw attention to risks from overseas as well as the dependency upon households’ consumption and investment (what they will actually do with what appears to be real income growth at last) to carry the next “turn” of the “virtuous circle” on which further accommodation withdrawal is likely dependent.”
