After months of posturing, promising, prevaricating, and proclaiming; the time is rapidly upon us where the central planner of the world will have to actually make actions rather than words. As SocGen notes, Central Bank decisions at the BoJ, ECB and BoE will take centre stage tonight/tomorrow but it is the BoJ announcement that is most highly anticipated after the epic jawboning. SocGen’s Sebastien Galy: “Only the truly brave can feel confident trading into the BoJ event”; adds, “It is not completely clear what economic consensus is expecting in terms of BoJ decision apart from broad outlines.”
The appointment of governor Kuroda and two new deputy governors has aligned the BoJ more closely to the government in pursuing a pro-inflation and growth agenda and tonight brings the first occasion for the new BoJ governor to make his mark. Hence expectations for a strong commitment to the new 2% inflation target and the policy demarche of an expanded asset purchase programme vs the existing 2013 year-end target of Y101trn.
In order to achieve the new inflation target, the BoJ looks set to expand its asset purchases substantially. Our base case is that the open-ended purchasing method will be brought forward from January 2014 to now. Moreover, we expect the rate of these open-ended asset purchases to be faster than currently planned, and not just for the year target for the size of the overall Asset Purchase Program at the end of this year would be raised from the current ¥101 trillion, which implied net growth of ¥36 trillion over the course of 2013. The likely magnitude of the increase in the APP by year-end 2013 would be in the order of ¥10 trillion.
Far more important, however, would be the impact on planned asset purchases in 2014. The current ‘open-ended’ purchases planned for 2014 were set at a rate of about ¥13 trillion per month (¥10 trillion of which would be T-Bills), but because of securities in the BoJ’s portfolio maturing, the planned expansion of the APP in 2014 is foreseen to be only ¥10 trillion, which would represent a sharp slowdown from the ¥36 trillion planned for 2013. At the time we described this as timid. The new BoJ leadership clearly wants to dispel all impressions of timidity, and is aiming for ‘bold’ policy action. Increasing the scale of asset purchases in the order of five-fold would certainly go a long way towards that.
FX markets have aggressively adopted short JPY positions since the election and government transition late last year and this has translated into a marked JPY/G10 depreciation. In relative terms however, compared to the IMM series history, the percentile of USD longs vs the JPY has stabilised around 95%. In other words, the risk of disappointment and short JPY covering cannot be underestimated should Kuroda underdeliver. With the latest Tankan business survey showing firms pencilling in an average USD/JPY rate of 85.00 for FY13, the BoJ clearly still has more work to do.
From a carry perspective, AUD/JPY and NZD/JPY are up respectively 10.9% and 9.8% this year and are expected to continue outperforming if the BoJ breaks with the piecemeal approach that has characterised recent policy history.
Expectations for the ECB and BoE are low key in comparison to Japan but risks of a policy upset are not totally negligible. Last month the ECB discussed lowering rates and the BoE governor has now been outvoted at two meetings in succession, vouching for an immediate £25bn increase in asset purchases to £400bn. With Eonias out to 1y effectively priced for further easing anyway, the message conveyed by president Draghi on Cyprus and his view on the EU Bank Recovery and Resolution Directive (BRRD) will be crucial for EUR/G10. Confirmation of reports that the ECB is establishing a program to reduce borrowing costs and boost lending to SMEs could trigger EUR short covering with 1.2890 a first obvious ST target for EUR/USD.
The governing council discussed cutting rates at the last meeting so the possibility of this happening tomorrow should not be entirely dismissed especially given the ongoing tightness in credit conditions. Over the inter-meeting period, periphery spreads over bunds have widened, leading indicators like the PMIs and EC indices have worsened, unemployment has risen and inflation slowed. But are the changes serious enough to convince the governing council that it should not wait to provide further stimulus?
The press conference could well be hijacked completely by the Cyprus rescue, the issue of capital controls, the lessons for future recovery and resolution, and the responsibility therein of bondholders and depositors. EU officials have spared no effort to emphasise that Cyprus was a unique case, but Moody’s has warned that default remains a risk and therefore the implications for other eurozone sovereigns are credit negative.
A split MPC vote in February and March suggests more QE is possible in the near-term, but could an increase come tomorrow? The BoE Q2 credit conditions survey released this morning revealed further improvement is expected in the availability of credit to households but not to SMEs. Demand is expected to pick up across ‘all firm sizes’ in Q2 after the decrease by SMEs in Q1. So even as spreads on lending are tightening thanks to competition and the Funding for Lending scheme, lending volumes are not picking up. Though governor King has now been outvoted at successive meetings, the rest of the committee may still prefer to bide its time until the Q1 GDP data are published later this month. Based on revised inflation and growth projections in the May Inflation Report will then lead the Bank to decide if another expansion of the asset purchase target is warranted.