- The BOJ shocked the world by broadening the trading range for the long-term yield from +/-25bps to +/-50bps while leaving the target 10-year yield around zero percent and policy rates at -0.1%.
- The decision was to improve Japanese government bond’s (JGB) market function as issues such as higher volatility and thinning liquidity have been on the rise which is impacting key financial operations like corporate financing.
- We think the BOJ’s recent move is evident that policymakers are warming up to the idea of normalising its monetary policy and the odds of tightening in 2023 have increased. We no longer see accommodative monetary policy as a reliable tailwind for Japanese equities.
- While we acknowledge that policies may tighten next year, Japanese equities are still attractive in our view, underpinned by i) reopening tailwinds, and an overall consumption-led growth in 2023, ii) buffer from a high proportion of cash-rich companies, iii) attractive valuations, and iv) currency tailwinds.
- We see the slump in Japanese equities after BOJ’s YCC announcement as an opportunity to accumulate greater exposure at even cheaper entry valuations. Given our currency view, we prefer an unhedged approach to Japanese equities, maintaining exposure to the yen.
How BOJ shocked the world
Chart 1: The 10-year JGB yield rose to its highest level since 2015 while the 10-year swap yield (not subjected to the YCC) surged even higher
What drove the move?
Chart 2: Degree of bond market functioning has deteriorated, with levels at its worst since YCC
Why now?
Is this the beginning of a policy shift?
- Unlike previous BOJ announcements this year, which are predominantly dovish, this move is a combination of hawkish policy action (widening the target band) and a dovish signal (pushback against rate hikes and tightening, increasing the amount and frequency of JGB purchases).
- Macro conditions are putting pressure on the BOJ to scale back its easy monetary policy. Japan’s inflation has climbed, with its core inflation hitting 3.7% in November, the highest it has been since 1981. Furthermore, a FY2023 shunto (Japanese wage negotiations) may see even greater demand for higher wages. Already, winter bonuses are reportedly set to rise at its largest year-on-year pace since the 1970s.
- The YCC has worked for much of its history, without the need for significant BOJ intervention, as deflation meant that rate hikes by the BOJ were near impossible. However, YCC has come under pressure in 2022 as the prospect of tightening no longer seems remote, with inflation rising and central banks across the world raising rates sharply. As conditions normalise, the BOJ will eventually have to take gradual steps to tighten its exceptionally easy monetary policy.
- In the BOJ’s prior meeting, policymakers indicated the potential for a policy review in 2023. The change of leadership at the BOJ next year may be opportune to further fine-tune the YCC.
- While Kuroda claims that this move is not to be taken as a rate hike or tightening, it contradicts what the BOJ governor said in September where he mentioned that lifting the upper bound would result in tighter monetary policy.
Implications for Japanese equities
Opportunity to accumulate greater exposure at cheaper entry valuations
Chart 3: Valuations fell further after the announcement. Japanese equities trading at 20% discount to long-term average
The Research Team is part of iFAST Financial Pte Ltd
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