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Japan Steps On the QE Gas

6 November 2014 in Trading Ideas

Japanese Prime Minister Shinzo Abe and his allies at the Bank of Japan may have just turned the spigot to “11.”

Last week, while the US Federal Reserve was putting an end to its program of bond buying, Japan’s central bank said it would keep theirs – and then some. The BoJ will increase its balance sheet by 15% a year, and will extend the average duration of its bond purchases to 10 years from seven years.1

As Gavyn Davies noted in the Financial Times, the move heralds open-ended bond purchases that are about 70% as large as the peak rate of bond purchases under QE3 in the US.

The BoJ’s announcement coincided with a statement by Japan’s government pension fund that it would reduce its domestic bond holdings from 60% of its portfolio to 35%, while increasing its overall equity holdings to 50% from 24%.

Davies wrote that the result will be to boost the purchase of Japanese equities by a further $90 billion, and the purchase of non-Japanese equities by $110 billion, all effectively financed by sales of $240 billion of bonds to the BoJ, and therefore effectively financed by central bank creation of reserves.

“The Japanese injection, relative to the size of the economy,” Davies wrote, “is far larger than anything attempted by the other major central banks.”

Davies’ FT colleague, John Authers, put it even more bluntly: “The BoJ successfully took the yen out to the woodshed and shot it between the eyes.”2

Lest we forget, Japan’s strategy is to force down bond yields with higher bond purchases. This, theoretically, would weaken the yen, because foreigners earn less putting their money into Japanese bonds. The weaker currency helps exporters, who are crucial to Japan’s economy.

As for the yen, Japan’s QE program has clearly made its mark. Authers pointed out that the yen is now the weakest against the dollar since 2008; it has fallen 32% since 2011.

A weaker yen also has directly translated to a stronger Japanese stock market. In the past 12 months, the Nikkei Index has gained more than 15%.

The QE Japan motif, a portfolio of stocks poised to benefit from central bank intervention in that country, has gained 0.6% in 2014. During that same time, the S&P 500 is up 11.3%.

In the past month, the motif has increased 4.6%; the S&P 500 has risen 3.1%.

Davies declared that the BoJ has clearly “doubled down” on the QE bet made jointly with Prime Minister Abe. “Faced with a slowing economy after the sales tax increase in April, and falling oil price inflation, the choice was either to abandon Abenomics, with no very obvious alternative to put in its place, or to prescribe a much larger dose of the same medicine,” he noted.

The risk, of course, is that even this move may not be sufficient. As Davies put it, noting that the yen is already 32% lower while real bond yields are well into negative territory, “If this does not work in stimulating nominal demand, then nothing the central bank can do on its own will work.”

That could mean that investors will be forced to consider whether an even-weaker yen justifies expectations for a significant upside in Japanese stocks.

1Gavyn Davies, “Bank of Japan opens the floodgates,” ft.com, Nov. 2, 2014.

2John Authers, “Bank of Japan shows central banks can still wield firepower,” ft.com, Oct. 31, 2014.

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