October 31, 2014, 17:00 JST

Kuroda knows when to go ALL in

Bank of Japan unexpectedly eased today (Oct.31) by announcing an expansion of their asset purchase program. It announced that it will increase its net JGB purchase from the previous annual pace of 50 trillion yen to 80 trillion yen. The bank will also increase the average maturity of JGB it purchases from the previous 7 years to 7-10 years (the mid point being 8.5 year). In addition to the expanded JGB purchase program, the BoJ will triple its purchase of equity ETF and J-REIT. 

Bank of Japan to raise the average maturity of its JGB purchase again 

 Source: BoJ, MoF, JMA.

The main thrust of the easing is in the expansion of its JGB purchase. In the run-up to today's decision, there were calls from other policy makers including former BoJ policy makers that the BoJ should start tapering and should not try to weaken yen further. Instead, the BoJ went the other way by accelerating its JGB purchase and implicitly helping to weaken yen further.

By expanding the amount of JGB it purchases and by extending the average maturity of them, the bank is almost doubling the intensity of its JGB purchase. By simple math, they were buying 50*7=350 trillion-yen-year worth of JGB risk per year till now. From now on, the bank will be buying 80*8.5=680 trillion-yen-year worth of JGB risk. The expansion is staggering. In our estimate, the BoJ will be owning close to 30% of the JGB market by the end of 2015, after adjusting for the duration risk, up from 24% in our previous estimate.

BoJ's duration adjusted JGB market share has already tripled 

 Source: BoJ, MoF, JMA.

Financial market implication

We expect the longer end of the JGB yield curve to flattened out. 30 year JGB yield is likely to approach 1% in the next few months. We also expect yen to weaken further. As the BoJ compresses the interest rate on the the longer end of the JGB yield curve, it will be hard for private investors to hold on to their JGB holding. Japanese life insurance companies who own sizable portion of the long term JGB market will need to divest away from JGB and buy other risk assets such as overseas bond and equity. 

Implication for fiscal policy and Japan's medium term future

The BoJ effectively is betting all it has to achieve its inflation target. In our estimate, it would have been 2020 when the BoJ owns 50% of the JGB market with the previous pace of quantiative easing. With today's announcement, the BoJ could end up owning 50% of JGB market by as early as in 2018. The BoJ is basically declaring that Japan will need to fix its long term problems by 2018, or risk becoming a failed nation.

The aggressive easing by the BoJ should also diminish the role fiscal policy should play in stimulating the economy. Prime Minister Abe is now 99% sure to announce that he will raise consumption tax rate as planned and the planned fiscal stimulus package does not need to be particularly large. The earlier than expected announcement of the monetary easing is also a call for fiscal policy makers to start paying larger efforts to achieve Japan's fiscal sustainability. We will see how fiscal policy makers respond. 

With its new QE policy, BoJ will own 50% of the whole JGB market by 2018