The central bank (communications) bubble
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Goldman strategists Naohiko Baba, Chiwoong Lee and Yuriko Tanaka’s considered opinion is that Haruhiko Kuroda is just, well, bad at central banker speak.
They think the loss of “any positive market reaction” to Japan’s unprecedented easing has “largely been undone”, and lay the blame mostly at the Bank of Japan chief’s feet for his communications strategy, or lack thereof.
(We’ve mentioned this before but it’s nice to get some backup.)
The Goldman trio spoke with various foreign buyers. They were surprised that the JGB market was not only the main focus of investors who concentrate on rates and forex, but also for equity investors.
It’s a fear of fiscal explosion that keeps them so attentive — “Given government debt is currently at 240% GDP and still rising, they probably see Japan’s fiscal state as fragile, which could potentially give way under further pressure.”
And it’s the overseas investors who are particularly nervous. It’s not too hard to see why:
Up to now, the driver of Abenomics has been overseas investors, but we see a significant gap between these investors and the BOJ in terms of the degree of concern over the instability of the JGB market. As a result, Kuroda’s remarks at a press conference post the May 22 monetary policy meeting were interpreted as an acceptance of further rises in longterm rates. Overseas investor confidence in the BOJ was further undermined at the June 11 monetary policy meeting when the BOJ decided to forego an extension to fixed rate operations after it was widely reported in the media and already factored into the market.
They go on to say, there were other factors — the disappointment in Abe’s Third Arrow, Fed-induced vol and so forth — but they reserve their greatest criticism by far for Kuroda.
He just doesn’t seem to have perfected the whole Jedi thing:
At the same time, inconsistencies in statements from Kuroda have caused confusion not only on the JGB market but also in the equity and forex markets. One specific example of this relates to his claim that the BOJ would aim to bring down the yield curve as a whole through large-volume JGB purchases. Kuroda made this claim when he introduced the unprecedented easing measures on April 4, and it was intended to be an important policy transmission channel. When long-term JGB yields started rising against his intentions, Kuroda said it wasn’t a problem as it was a result of inflation/growth expectations. Somewhat sardonically, the expected inflation rate (an indicator frequently referred to by both Kuroda and Deputy Governor Iwata; represented by CPI index-linked JGB movements) began to decline sharply after May 22, when Kuroda made the statement about rising bond yields (see Exhibit 3).
The BOJ also used the buzz word “portfolio rebalancing” to describe the effects its increased presence on the JGB market would have in encouraging institutional investors (banks, life insurance companies, etc.) to move away from the JGB market and into other markets, such as lending and foreign assets. Some institutional investors actually sold off JGBs as the BOJ expected, but market liquidity dried up with the resulting exit of these liquidity providers. This in turn increased market volatility, and some other market participants came under pressure to sell their JGB holdings in order to manage their risk, which fuelled a malignant cycle of further instability. The BOJ was left as one of the few buyers on the JGB market, and it is also being criticized for reducing market liquidity because of the lack of clarity around its large-lot JGB buying operations. Also, equity prices of some regional banks declined as a result of their substantial JGB yield risk exposure and the current instability of yields as well of concerns about future yield rises. We also need to be aware of the risk that they might attempt to sell even more JGBs than they need to if the JGB market continues to be volatile in the future.
The rumblings in the JGB market have transferred to the equity and forex markets as well…
In order to investigate this phenomenon more rigorously, we analyzed the reaction in volatility of equity prices and forex rates when long-term JGB yield volatility changes by 1% (see Exhibit 6). We can see a big change in trend from May 22, when Kuroda held his post policy meeting press conference. Equity and forex volatility began reacting strongly to changes in JGB yield volatility with a particularly noticeable reaction in equity volatility.
Of course, it’s not the first time we’ve come across central bankers who think they are being clearer than they really are…. so we hope if Kuroda decides to call one of his peers for help, he doesn’t make matters worse. We will be tracking his learning curve with interest, particularly as he navigates the potential need to “credibly promise to be irresponsible” considering all of the issues above.
Or, as Goldman put it:
It will not be an easy task to completely rebuild confidence in the BOJ among overseas investors after it has been undermined, and the BOJ will not be able to easily pull out of its 2% price target after committing to it. We therefore see a need for the BOJ to offset this with an improvement in its communication strategy. We especially see a need for the BOJ to clearly outline its basic intentions and provide, in a consistent manner, a time frame for how long-term yields will be formed under the unprecedented easing. It also needs to establish specific measures to stabilize the JGB market in case of an emergency. Unprecedented easing relies overwhelmingly on financial market transmission channels, and it is important for the central bank to urgently rebuild stability thereby enhancing the visibility for the main players on these markets – overseas investors.
By Kate Mackenzie and David Keohane
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