This morning the Nikkei index has dropped has much as 6%. By any measure this is an extreme drop in stock prices in one day. Furthermore, we are now officially in bear market territory as the Nikkei is down more than 20% in just three weeks. I can only see one reason for this and one reason only and that is the breakdown of the credibility of Bank of Japan governor Kuroda and his commitment to fulfill his official 2% inflation target.
I would particularly highlight three events for this breakdown of credibility.
First of all I would stress that it seems like the Japanese government has been taken by surprise by the natural increase in bond yields and that is causing officials to question the course of monetary policy. This is Economy Minister Akira Amari commenting on the increase in bond yields on May 19:
“We need to enhance the credibility of government bonds to prevent a rise in long-term yields.”
Second the Minutes from Bank of Japan’s Policy board meeting on April 27 released On May 26 and comments following this week’s monetary policy meeting.
This is from the May 26 Minutes (quoted from MarketWatch):
“Regarding the effects of JGB purchases on liquidity in the JGB and repo market, a few members … expressed the opinion that it should continue to deliberate on measures to prevent a decline in liquidity”
Said in another way some BoJ board members would like the BoJ to try to keep bond yields from rising – hence responding to Mr. Amari’s fears. There is fundamentally only one way of doing this – abandoning the commitment to hit 2% inflation in two years. You can simply not have both – higher inflation and at the same time no increase in bond yields. Bond yields in Japan have been rising exactly because Mr. Kuroda has been successful in initially pushing up inflation expectations. It is that simple.
And third, at the BoJ’s monetary policy announcement this week Bank of Japan governor Kuroda failed to clarify the position of the BoJ and that undoubtedly has unnerved investors further.
Hence, it is important that market turmoil does not reflect a fear of higher nominal bond yields on its own, but rather whether higher bond yields will cause the BoJ to abandon the commitment to increase inflation to 2%.
Therefore what is happening is a completely rational reaction from investors that rightly or wrongly fear that the BoJ is changing course.
As I again and again has stressed Mr. Kuroda can end the market turmoil by first of all stating that the increase nominal bond yields is no worry at all (particularly as real bond yields actually have dropped sharply) and furthermore he should clearly state that the BoJ’s focus is on inflation expectations. Hence, he should state that the BoJ effectively is ‘pegging’ market (breakeven) inflation expectations to 2%. If he did that he would effectively have hindered inflation expectations dropping over the past three weeks. The drop in Japanese inflation expectations in my view is the main cause of the turmoil in global financial markets over the past three weeks.
Should we give Mr. Kuroda a break?
I might be too harsh to Mr. Kuroda here. After all should we really expect everything to be ‘perfect’ at this early stage in the change to the monetary policy regime Japan after 15 years of failure?
This is the alway insightful Mikio Kumada commenting on Linkedin on one of my earlier posts on Japan:
“Lars, give it some time. The regime change at the BOJ is still very new and the ideological shifts in old conservative institutions, with long traditions, such as the BOJ take some time. I think Kuroda made it implicitly clear enough that higher nominal rates are ok as long as real interest rates slump/stay low.”
I think Mikio (who like a lot of market participants, central bankers and monetary policy nerds have join the Global Monetary Policy Network on Linkedin) is on to something here.
We are seeing a revolution at the BoJ so one should not really be surprised that it is not all smoothing sailing. However, on the other hand I am personally very doubtful where we are going next. Will Kuroda effectively be forced by events to abondon his commitment to 2% inflation or will he reaffirm that by becoming much more clear in his communication (don’t worry about higher nominal bond yields and communicate clearly in terms of inflation expectations).
I have my hopes, but I don’t know the answer to this question, but one thing seems clear and that is that nearly everything in the global financial markets – from the value of the South Africa rand, commodity prices and the sentiment in the US stock markets – these days dependent on what Mr. Kuroda does next. Don’t tell me that monetary policy is not important…
PS David Glasner is puzzled by what is going on the US financial markets. I think I just gave the answer above. It is not really Bernanke, but rather Mr. Kuroda David should focus on. At least this time around.
Mattias
/ June 13, 2013I fear that if this “experiment” ends badly, it will be devastating for the idea that tight money is the problem, in Japan as well as in other markets.
Regarding the uncertainty in the markets right now, I think the situation in Europe might play a part too. Draghi saying deflation is not that bad and Hollande claiming that the euro crisis is over – it feels like we should get ready for the next act in this tragedy.
Thank god that Sweden didn’t join (although I voted for it).
Chun
/ June 13, 2013Lars, just curiosity, would you let me know how you’ve got 5 year inflation expectation data?
Lars Christensen
/ June 13, 2013Chun,
The source is Bloomberg ( – it is 5-year breakeven inflation expectations (JYGGBE05 Index).
q-chan
/ June 13, 2013One more thing
http://ajw.asahi.com/article/views/AJ201306080032
Benjamin Cole
/ June 13, 2013Excellent blogging.
As MM’ers have said, a central bank must have a clear, public and firm goal in mind. Waffling, stop-and-go, dithering, and feebleness do not convince markets.
If the BoJ crumbles again, I think we see perma-rcession in Japan. What a sad story, The BoJ is suffocating Japan.
The big risk to Europe and the USA is pundits and even Phd economists will seize on Japan’s record and say “See, QE doesn’t work.”
When fighting inflation, centrals banks must show resolve. When stimulating, central banks must show even greater resolve. Volcker cut inflation down to size rather quickly. Obtaining sustained growth may take longer, and thus require more resolve,
Mikio Kumada
/ June 14, 2013Lars, thank you for the mention.
Just wanted to say that in substance, I share your concerns. And I think it’s important that you raise these questions/criticisms.
I am, however, perhaps, less ideological, and try to look at things in the context of the real world.
Policy makers act in a political/institutional framework, with constraints. And in that context, the BoJ under Kuroda is dong a good job – as good as it gets, so to speak, from a market monetarist perspective.
By the way, yesterday, Kuroda met Abe and both made statements afterwards. Neither of them mentioned the need to keep interest rates low. They said all the other things – Kuroda reaffirmed he will beat deflation and Abe said he will do his part via reforms, but they didn’t make statements about interest rates.
That is another indication that Kuroda believes that higher nominal rates are desirable, and logical. And he may have convinced Abe not to talk about “lowering interest rates” (if Abe needed any convincing). But at the same time, Kuroda can’t yet openly that say he wants rising nominal rates.
My sense is that Kuroda, and also Prof. Koichi Hamada, a trusted advisor to Abe, are open to market monetarist ideas. But they would probably face a hailstorm if they openly say things that are too “revolutionary”. They first have to convince enough people that rising nominal yields are good, as long as real yields (and real wages) remain low, or keep falling during the “reflation” phase. But I would not recommend Abe to talk too much about “falling real wages” publicly ahead of an election, of course. He should just stick to demanding rising (nominal) wages.
I also sense that yesterday’s decline in stocks may have been due to (an erroneous) “disappointment” of investors that Abe/Kuroda didn’t say they want low/lower long term rates.
So, overall, I remain quite optimistic that, over time, the market will come around to accept the view that higher nominal rates are a good thing.
Regards,
Mikio
Lars Christensen
/ June 14, 2013Thanks Mikio,
I am also fairly optimistic – as optimistic you can be after a 20% drop in the stock market. But as you say I think it is important to make these points. To the extent that anybody in Tokyo are reading my blog posts I hope they are helpful in pushing policy in the right direction.
This morning optimism obviously is back.
andrew
/ June 19, 2013Hi Lars. I just came across your comments. I was wondering what you thought of Kuroda’s latest statements, particularly on the effect you think they will have on the Dollar / Yen cross. So far, both the yen and the Nikkei are up after his speech. Is your view on the Nikkei independent on your view on the yen? Thanks in advance for any comments. They are greatly appreciated.