BoJ: From QE infinity to QE exhaustion? - Westpac

Research Team at Westpac, suggests that in the last few weeks, markets have started to question whether we may be approaching the limits of QE and while it is surprising how quickly it has happened, there are real risks that the yield sell-off can continue, depending on what the Bank of Japan (BoJ) announces next week.

Key Quotes

“QE Infinity?

In the last 10 years, the balance sheets of the Fed, ECB and BoJ have increased by an incredible US$9.2tn from US$3.3tn to US$12.5tn. The Fed clearly led the charge in various waves from 2008 to 2014. However, the Fed’s balance sheet has been static at US$4.5tn since Jan 2015.

Clearly, the baton was passed on and the BoJ’s aggressive QQE/QQME programs announced on April 1 2013 and expanded on October 31 2014 (and then NIRP in January 29 2016) has had an enormous impact on the size of the BoJ’s balance sheet. The BoJ’s balance sheet is about to cross over the Fed’s, helped in part by the appreciating ¥.

The BoJ’s balance sheet is multiple times the size of the Fed’s. On a per capita basis, it is 2.5 times the Fed balance sheet. On a GDP basis, it is 3.6 times the Fed. With the BoJ set to continue buying Japanese Government Bonds (JGBs) and other assets with a view to increasing monetary base at an annual pace of about ¥80tn per year (US$0.8tn), there is very little doubt that the BoJ’s balance sheet will be larger than the Fed’s in coming months.

QE limits?

So what might this limit be? Indeed, 75% of the balance sheet comprises JGBs. This aggressive and sustained buying program means the BoJ now owns 33% of available JGB (Central government securities and FILP bonds).

So if Japanese banks (including the Post Bank) have been the major seller of JGBs, can this continue at the same pace going forward? We suspect we are getting closer to the point where the answer would be no.

QE Exhaustion?

We have long believed that not only is the BoJ facing low growth, a rapidly aging population and deflation but also a deep rooted risk aversion within balance sheets in Japan. This has always created a nagging doubt in our minds as to whether the BoJ’s QQE policies could ever be successful even if it hit all its asset purchase/ expansion of base money targets.

Is more NIRP the answer?

Is more NIRP the answer? We think so. If Japanese depository corporations cannot differentiate between zero yielding JGBs and cash, then charge to hoard cash. In effect, the BoJ should double down on the NIRP policy announced in January. We also think the BoJ should widen the range of deposits captured to include more than just current accounts that financial institutions hold at the Bank.

Helicopter money? Operation twist? Foreign bonds?

So which assets can help replace JGBs? We see strong merit in other assets including Zaito bonds and FILP projects bonds, though these could never replace the staple JGB asset of choice. “Helicopter money” may offer a “way out”.

FX impact?

To be sure, a “QE exhaustion” signal from the BoJ is of course a vastly different proposition to an active tapering in purchases or an outright decline in the size of the BoJ’s balance sheet. The BoJ’s balance sheet is set to remain bloated for an indefinite period. That said, any hints from the BoJ that it has reached the limits of QE in its current form would nevertheless likely lead to significant dislocation in global markets – a significant decline in risk appetite and a sharp decline in USD/JPY in short order.

The BoJ has been at the forefront of QE developments over the last three years. Thus a BoJ ‘QE Exhaustion’ signal next week could drive a global bond market sell-off further. Now, this is not our core call. The Fed is likely to again cut its longer run target level for Fed funds below 3% in either September or December meeting, limiting the ability for US bonds to sell off too much; while the ECB did not exactly instil confidence in the outlook for ECB purchases beyond March next year, it will continue buying €80bn per month; BoE asset purchases are gearing up and even if the BoJ is approaching the limits of JGB asset purchases, it can carry on as is for many months to come. So it is not clear to us that the current bond market sell-off continues too much further. However, risks have certainly risen and much now depends on what the BoJ delivers next week, and the ECB in December. This is something our colleagues will consider in subsequent work.”