A meaningful first step by the Bank of Japan to normalise monetary policy

The Bank of Japan (BOJ) finally announced a change in its Yield Curve Control (YCC) policy today. In and of itself, the move was modest, with overnight interest rates staying put at -0.1% and the YCC band for 10-year Japanese government bonds (JGBs) widening from 25bps to 50bps. (This is the amount bond yields would be allowed to move either side of their 0% target). 

In symbolic terms, however, the step is far more meaningful. Whilst markets had not been expecting a move in December, recent intimations from the BOJ had started to guide the market toward a pivot at some point in 2023. 

Following the announcement, the yen rallied around 3% versus the US dollar, the Nikkei share index fell 2.5% and 10-year JGB yields rose to 0.46% (the highest level since 2015).

As equity investors, we do not make it our business to forecast macro policy and we had no expectations for a policy change in December. However, we have believed that Japan’s monetary policy was at odds with the prevailing growth, inflation and wage backdrop in Japan, which is as constructive as we have seen it this century. 

The Japanese economy appears to be one of the few globally likely to experience a sequential rise in real GDP in 2023. It is one of the few with a steep rather than inverted yield curve. JGB yields have been pushing against the BOJ’s YCC upper limit throughout 2022, prompting extraordinary bond purchases from the BOJ. Meanwhile, the yen’s material decline has imported yet more inflationary pressure, inviting direct Ministry of Finance intervention. Something had to give. 

In terms of Japan’s equity market, the relatively positive and resilient trend in Japanese earnings revisions in 2022 has been helped by a weak yen and it is not unreasonable to expect the market to price in at least a partial reversal in this. No doubt, the punditry will be recommending the relative attractiveness of financials vs exporters in the near-term and sector gyrations seem likely as investor positioning is expected to adjust in the weeks ahead. We currently have no plans for major portfolio changes but remain alert to opportunities. 

Whilst a sudden overshoot of the currency from one extreme to another cannot be ruled out, we are not unduly concerned by the near-term prospects for enhanced volatility. For us, the big picture is clear. We believe that Japan has exited its affair with structural-deflation. We suspect the BOJ is gradually becoming more comfortable with this same idea. The BOJ is however keen to avoid dislocation in bond and currency markets and wants to move incrementally. 

Today’s announcement should be seen as the first step towards normalisation of policy, in our view. Normalisation reflects healthier economic fundamentals and should be celebrated. In the near term, volatility may be elevated as a more balanced view of the yen needs to be digested. After all, the yen was above 150 versus the dollar just a few weeks ago. This move back to 132 has been fairly sharp and today’s BOJ announcement might lead to some realisation and indeed concern that a move back to 115, where it started 2022, is not implausible for 2023 or 2024.

Japanese equities remain an attractive, long-term investment opportunity

Our view throughout 2022 is that Japanese equities represent a compelling and attractive, long-term investment opportunity. Structural earnings growth derived principally from corporate self-help is at the core of our thesis. Our view has not changed. Indeed, the more constructive outlook for prices and wages adds to our long-term optimism. With the yen reaching meaningfully into “cheap” territory in the late summer, in our opinion, Japan suddenly offered cheap equities in a cheap currency.