BoJ, the world’s most dovish central bank, is still some way off draining liquidity from the financial system, but its decision to relax its “yield curve control” – effectively doubling long-term borrowing costs in the process – brings into view the day it finally stops adding liquidity. — Reuters
IF you were hoping a US soft landing, coming down the other side of inflation and interest rate peaks would smooth the path for world markets next year, the Bank of Japan’s (BoJ) shock policy pivot on Tuesday may force a rethink.
The world’s most dovish central bank is still some way off draining liquidity from the financial system, but its decision to relax its “yield curve control” – effectively doubling long-term borrowing costs in the process – brings into view the day it finally stops adding liquidity.
This would be momentous. The BoJ has for decades been the world leader in ultra-loose and unconventional monetary policy in its long-running battle against deflation, most recently committing to buying unlimited amounts of government bonds to cap the 10-year yield around 0.25%.
As the Federal Reserve (Fed), European Central Bank (ECB), Bank of England and other Western central banks to varying degrees drained the liquidity punchbowl this year by raising rates and initiating quantitative tightening, the BoJ was on the other side with the People’s Bank of China (PBoC) filling it back up again.
The BoJ stepping back would leave the PBoC in a minority of one. And even then, it’s not inconceivable that China’s economic reopening is successful enough to prompt policymakers in Beijing to revise or even reverse their easing bias.
Liquidity support for world markets next year was always going to dwindle, but few would have had a possible BoJ halt to asset purchases on their bingo card so soon.
Matt King at Citi in London reckoned the BoJ bought around US$200bil (RM887.5bil) of bonds over the last year, but it now seems “highly likely” that this will shrink next year.
“That isn’t quantitative tightening (QT), but it does add to the extent to which the wave of central bank liquidity which has powered risk assets is gradually being withdrawn and even reversed – with negative consequences for risk assets,” King said.
Before BoJ surprise, King had estimated that major central banks were on course to drain around US$1.5 trillion (RM6.65 trillion) of liquidity from the global system next year, implying a 15% decline in world stocks, all else equal.
This year has been one of the worst ever for world markets, hammered by multi-decade high inflation and interest rates across much of the developed world, and a rampant dollar. Both stocks and bonds have plummeted.
Analysts at Morgan Stanley in June were more aggressive than King in their QT forecasts. They predicted that the aggregate G4 central bank balance sheet would shrink by more than US$4 trillion (RM17.75 trillion) over the following 12 months.
“The largest expansion of central bank balance sheets in history will give way to the largest contraction in history,” they said.
The BoJ would account for virtually none of that.
The Fed has since outlined a programme to reduce its balance sheet by no longer investing the principal and interest payments received from maturing Treasuries and mortgage-backed securities.
The ECB last week laid out plans to stop replacing maturing bonds from portfolio.
The BoJ is well behind its three peers, but the real surprise on Tuesday was its timing, not direction.
Inflation is approaching 4% – almost double the BoJ’s target – and the BoJ balance sheet and domestic market distortions are growing rapidly.
In some ways this bolt from the blue on Tuesday is the perfect bookend to one of the most unpredictable and turbulent years ever for financial markets, and suggests next year will be far from plain sailing either. — Reuters
Jamie McGeever writes for Reuters. The views expressed here are the writer’s own.
