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Tomoya Masanao, co-head of Asia-Pacific portfolio management, co-head of PIMCO Japan, discusses why the Bank of Japan’s exit from monetary easing provides fresh opportunities for bond market investors.
The Bank of
Japan (BOJ) has bid farewell to its negative interest rate
policy (NIRP), yield-curve control (YCC) and quantitative and
qualitative easing (QQE), marking the end of an era of
extraordinary monetary easing.
This paves the way for a more normalised Japanese bond market,
offering fresh opportunities for investors who have been wary of
this space over the past decade, according to Tomoya Masanao
(pictured) at PIMCO
Japan.
The BOJ”s shift from a complex and overly accommodative stance
(combining NIRP, YCC and QQE) to a 0 per cent to 0.1 per cent
positive policy rate and a simpler approach was no surprise. “The
fundamentals were supportive, and the changes were well
telegraphed ahead of the BOJ’s meeting,” Masanao said in a note.
Like its peers, PIMCO has been trying to make sense of changes in
Japan’s economy and financial markets. Having languished for
decades after stocks and real estate markets slumped in the late
80s, Japan has at last recovered some of its older energy.
Inflation expectations in Japan have been largely re-anchored to
more positive levels, PIMCO noted. The combination of global
inflation induced by COVID-19 and a weak yen, exacerbated by
central bank policy divergences, served as the catalyst Japan
needed to break free from entrenched deflationary expectations
and offered an opportunity for the BOJ to retire some of its more
inflexible policies.
The BOJ’s pre-meeting communications underscored its expectations
that it would maintain an accommodative policy stance, including
the continuation of government bond purchases, Masanao continued.
This cautious rate increase is strategically aimed at managing
the potential uptick in bond yields without causing market
disruption.
A new inflationary landscape for Japan
Masanao believes that the BOJ’s policy changes, while largely
anticipated, should have minimal immediate market impact.
However, the medium- to long-term implications could be
significant, as the potential scale of the BOJ’s policy changes
may be more than the financial markets currently anticipate.
A key question is whether Japan’s trend inflation rates will
stabilise post-pandemic. Although Japanese inflation has shown
signs of moderation, and further moderation is quite possible,
Masanao believes that the country appears to have settled into a
“1-point-something” per cent inflation rate, if not 2 per cent.
This marks a significant departure from the near-zero per cent
trend of the past three decades.
This new baseline represents a structural shift in the labour
market and corporate pricing behaviour. The pandemic’s global
inflationary impact, coupled with the yen’s depreciation, has
been a major catalyst for significant shifts in inflation
expectations and corporates’ price and wage-setting behaviour,
Masanao continued. While the BOJ’s 2 per cent inflation target
remains elusive, given the country’s still inflexible labour
system and low productivity, he believes that a reversion to zero
per cent inflation seems equally unlikely.
BOJ policy in the new inflationary context
Although the BOJ reiterated its commitment to the 2 per cent
inflation target, it is improbable, in his view, that the BOJ
will maintain its accommodative monetary policy indefinitely to
secure achieving its 2 per cent target. A more realistic
approach would be to accept a 1 to 2 per cent inflation range as
a practical target for a nation with low economic growth
potential.
Outlook for investors
For investors, Masanao believes that the Japanese bond markets
should start offering a higher risk premium and modestly higher
yields in response to the BOJ’s continued policy adjustments and
the transition of government bonds back to market forces. As the
market digests the new and evolving policy stance, there will be
tactical opportunities for active managers to capitalise on the
inefficiencies in the Japanese bond and interest rate swap
markets during this period of increased volatility, he said.
Structurally, however, Japanese investors are generally
underweight in Japanese bonds. Masanao believes that they should
consider increasing their allocations over time given the higher
yield levels. Although he anticipates a modest uptick in bond
yields, the trajectory is expected to be gradual and nuanced on
the yield curve. Japanese bond yields are correlated with global
counterparts, and with major central banks poised to initiate
rate cuts this year, any sharp yield fluctuations in Japan could
prompt BOJ intervention, he added. The positive carry from
Japanese bonds, supported by a steep yield curve, should
over time offer a buffer for bondholders against rising yields.
Masanao does not expect Japanese investors to significantly
influence market dynamics globally. Domestic flows into Japanese
bond markets will rise, but he doesn’t expect those
investors will have an urgent need to offload foreign bonds in
favour of Japanese duration. Japanese investors possess ample yen
liquidity to deploy domestically and there is a discernible
demand for US duration to hedge against potential recession
risks.
Wrapping up, Masanao said that the BOJ’s policy evolution should
usher in a period of normalisation for Japanese bond markets,
eventually attracting investors at higher yields who have been
hesitant to invest over the past decade. See more commentary
about Japan
here.
PIMCO is a US investment manager, specialising in fixed
income.
