Bill Witherell isCumberland Advisors' chief global economist. He joined Cumberland after yearsof experience at the OECD in Paris. The views and opinions expressed in thispiece represent only those of the author and are not necessarily those ofS&P Global Market Intelligence.
Investors around the globe had anxiously awaited the resultsof Wednesday's meeting of Japan's central bank, the Bank of Japan. Japan is thethird-largest economy in the world after the U.S. and China. It has beensuffering from weak economic growth for the past two decades, along withstubborn deflation, ever-rising government debt, and an aging and decliningpopulation. The BOJ has pursued quantitative easing, first during 2003-2006 andthen on a much more massive scale since April 2013. This past January the BOJannounced it would supplement its QE program by setting a negative policyinterest rate. These policies have clearly lowered interest rates and pumpedenormous liquidity into the Japanese economy. However, spending by consumersand businesses has remained sluggish, and there has been no progress toward theBOJ's objective of 2% inflation. Indeed, consumer prices may register a smalldecline for the current year, with GDP growth of only about 0.5%.
The BOJ on Wednesday announced a major resetting of itsmonetary policy, based on a "comprehensive assessment of the developmentsin economic activity" under its policy of "quantitative andqualitative monetary easing (QQE)" together with "negative (policy)interest rate" and a "price stability target of 2%." Therevamped policy is called "QQE with Yield Curve Control" and iscombined with an "'inflation-overshooting commitment' in which the Bankcommits itself to expanding the monetary base until the year-on-year rate ofincrease in the observed consumer price index (CPI) exceeds the price stabilitytarget of 2% and stays above the target in a stable manner." These arevery significant changes.
The yield curve control policy means the BOJ is now going tofocus on the yield curve and, more specifically, target the yield on 10-yearJapanese government bonds (JGBs) "so that 10-year JGB yields will remainmore or less at the current level (around zero percent)." The bankabolished its guideline for the average remaining maturity of its JGBpurchases, which had led to buying fixed quantities of JGBs at variousmaturities. It has moved to a more flexible policy of adjusting the volume ofasset purchases in the short run to control bond yields while still keeping thelonger-term target of expanding its JGB portfolio by about ¥80 trillionannually. These changes toward rate targeting and increased flexibility in theBank's quantitative easing should dampen the debate about the possibility ofthe bank running out of assets to buy and should address concerns about theexcessive flattening of the yield curve and the adverse effects of the negativepolicy interest rate on banks and pension funds. The bank kept unchanged (atnegative 0.1%) the negative rate it imposes on bank reserves held at the bank.It can now lower this rate further if warranted while still maintaining thetargeted 10-year yield at the present level.
The change in the inflation policy target to one ofovershooting the 2% rate "in a stable manner" is clearly a dovishmove, signaling to markets the strength of the BOJ's commitment to press aheadwith all means at its disposal to counter deflationary tendencies and achieveits price stability objective. This implies that monetary base expansion willbe continued indefinitely.
There was also an important adjustment to the bank's programof purchasing Japanese equities. While the total amount of equities purchasedremains unchanged, the bank will reduce the purchases of ETFs that track theNikkei 225 stock average and buy more ETFs that track the much broader TOPIXindex. This change responds to concerns that the previous emphasis on theNikkei was distorting prices in that market. The TOPIX bounced 2.7% Wednesday,compared with the Nikkei 225's advance of 1.9%.
We consider this policy revamp by the Bank of Japan to bepositive for the Japanese economy and its asset markets. The bank's targetingof the 10-year bond rate while increasing the flexibility of its quantitativeeasing and maintaining its negative policy interest rate is clearly a move intouncharted waters. BOJ Governor Haruhiko Kuroda stated that controlling theyield curve is "quite doable." It will likely be a challenge. Thereis no immediate increase in monetary policy stimulus from the policy reset. Thechanges should, however, reduce the negative effects of the bank's policy andmake it more sustainable and easier to expand in the future. The new inflationtarget should give a needed boost to inflation expectations. These developmentsmay eventually lead to some easing in the exchange rate for the yen, althoughthe expected steepening of the yield curve and the U.S. Fed's delay in raisingrates could work against yen depreciation.
The BOJ's outlook for the Japanese economy is "amoderate expanding trend." Exports are expected to remain"sluggish," as is production. Monetary policy will remain supportive,and fiscal stimulus is projected to increase. Progress on economic reforms ispromised and is greatly needed.
Japan's equity markets responded favorably to the new BOJ policies,as noted above. The Japan ETFs that are currently in Cumberland's Internationaland Tactical Trend Portfolios are reflecting this movement. The iShares MSCIJapan ETF, EWJ, rose 2.93% Wednesday, and is up 5.28% for the year-to-date. TheiShares MSCI Japan Small-Cap ETF, SCJ, advanced 2.54% and is up 7.34%year-to-date. The currency-hedged WisdomTree Japan Hedged Equity ETF, DXJ, rosea more modest 1.97% as the yen increased by about 1.3% versus the U.S. dollar.The 19% increase in the yen-USD exchange rate this year is reflected in DXJ'syear-to-date decline of 13.41%. If the yen does start to decline as the BOJpolicy changes take hold, this ETF will continue to recover, likelyoutperforming unhedged Japan ETFs.