Timothy Schluter
Monetary Policy

The Bank of Neverland

By, 02/10/2016
Ratings494.32653

Pundits have taken to calling the Bank of Japan’s latest policy trick—negative interest rates on central bank deposits—a Jedi Mind Trick. But BoJ Governor Haruhiko Kuroda seems to have a different pop cultural inspiration when he stated last year: “I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it.’ Yes, what we need is a positive attitude and conviction. Indeed, each time central banks have been confronted with a wide range of problems, they have overcome the problems by conceiving new solutions.”

Trouble is, in Peter Pan, flying also required magic fairy dust, and neither quantitative easing (QE) nor negative interest rates qualify. They’re more like forcing banks to walk the plank.

The BoJ’s massive QE program, now coupled with negative interest rates on new excess reserves, has pushed Japanese yields negative all the way out to 10-year maturities. Negative yields are intended to make Japanese Government Bonds (JGBs) unattractive—effectively a “tax” on savers (lenders)—promoting consumption or investment in higher yielding or riskier assets. Yet in the short term, it has done the opposite. 

Exhibit 1: QE Has Pushed Yields Negative

Source: FactSet, Fisher Investments Research, as of 02/09/16.

Exhibit 2: And Loan Growth Remains Anemic

Source: Bank of Japan, as of 1/31/16

BoJ policy hasn’t changed banks’ eagerness to lend, which remains all but nonexistent despite the new charge on excess reserves. Real returns on loans remain low, and banks don’t have sufficiently attractive or willing borrowers to accelerate loan growth. Japan’s weak loan demand is less about rate dependency and more about anemic future expectations for growth, falling real wages, poor demographic trends, lack of investment opportunities and much more—factors outside the scope of monetary policy.    

While the BoJ’s QE program didn’t stoke lending or inflation, it did crater the yen, which improved exporters’ repatriated profits and buoyed local equity markets. This intended “wealth effect” was supposed to create a virtuous cycle of consumption, wage increases and rising inflation expectations. This basically hasn’t happened, despite the BoJ now buying ~100%+ of JGB net issuance and amassing holdings equaling one-third of the entire JGB market. This figure is expected to reach 50% by the end of 2017.

More or less unnoticed is the BoJ’s equity ETF purchasing. The Bank bought $300 million in ETFs each of the six trading days through 02/10/16 as it offered support at the market open. While the daily size of buying is not large in the context of the entire equity market, more alarming is the BoJ now owns over 50% of the Japanese ETF market.

I don’t claim to know the end game, but some posit the next step after exhausting the capacity for JGB buying, negative rates and ETF purchases would be directly purchasing stocks. December’s ETF program expansion may be a clue. The BoJ committed funds in 2016 towards yet-to-be-created ETFs of companies “proactively making investment in physical and human capital.” If the Bank is not satisfied with the outcome, the next step could be directly investing in companies it believes are being managed in parallel with the BoJ & Abe administration’s vision (capex spending, increasing wages, etc.). This would undoubtedly introduce unintended consequences as the Bank is sure to misallocate capital—as any government or central bank in the same position would.

Japan has some history of direct and indirect stock market intervention. The government urged pension funds and life insurers to buy equities after the 1987 crash—similar to recent coaxing of the $1 trillion-plus Government Pension Investment Fund to rebalance toward domestic equities. In 2002, the BoJ shocked markets by directly purchasing cross-shareholdings of large banks to shore up balance sheets.

It may seem far-fetched for a central bank to buy stocks as a policy tool, but Gov. Kuroda has shown he places a high premium on changing investor expectations through surprise and unconventional monetary policy. But it takes more than creative monetary policy to restore economic dynamism, and for Japan, it will take deep reforms to address its long-running structural issues. Monetary madness, coupled with a lack of reform, likely make Japanese stocks unattractive for the foreseeable future.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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