Don’t fear the Bank of Japan taper just yet

Do global markets now have to fear a Bank of Japan taper tantrum?

That’s the buzz in currency circles amid media reports Governor Haruhiko Kuroda is mulling a move away from Tokyo’s crisis-mode stimulus.

But here are three reasons it’s premature to think the BOJ is about to exit its historic quantitative-easing regime.

One, the economy isn’t ready.

True, Prime Minister Shinzo Abe’s reflation program is having a good moment. Japan is enjoying its longest expansion since 2001, the Nikkei is near 26-year highs and Abenomics is wooing foreign investors again.

A dearth of wage growth and inflation, though, suggests there’s nothing self-reinforcing about Japan’s 1.4 percent annualized growth rate.

Take away the BOJ’s cash spigot and surging government borrowings, and Japan would likely lose momentum in short order. The yen would rally if the BOJ took even the slightest step toward tapering, denting the all-important export engine.

Any rise in bond yields would be a powerful headwind. For all Abe’s talk of fiscal consolidation, remember, Japan’s national debt increased $13 billion over three months to a record 1,080,441 billion yen in September. Japan still needs its financial steroids to perform.

Two, the BOJ is still the only game in town.

After Abe’s election wins in 2012 and 2014, investors hoped he’d accelerate structural reforms to loosen labor markets, increase productivity and boost innovation. To no avail, as Abe pivoted to national security concerns.

Whether Abe will harness his October 22 election triumph this year to roll up his sleeves and modernize Japan Inc. is an open question. A month on, little has happened to suggest an Abenomics 2.0 is afoot.

Abe’s deserves credit for tightening corporate governance a touch and resurrecting the Trans-Pacific Partnership after U.S. President Donald Trump quit the deal.

But increased global trade hasn’t raised Japanese wages appreciably in decades. What’s needed is the deregulatory big bang Abe has talked of for five years now. Domestic demand-led growth could be Tokyo’s for the taking if it relied less on BOJ cash and more on legislative and regulatory upgrades.

Three, we’ve seen this film before.

In 2015, traders indulged in a mini-panic as BOJ officials hinted at withdrawing from asset purchases. Japanese government bond yields and the yen rose, while stocks fell.

The BOJ confounded the hawks in early 2016 with its negative rates gambit. Since then, “open-market operations” from BOJ staff have erred on the side of more easing, not less.

Now, a new Reuters report suggests the central bank is devising ways to step away from crisis-mode stimulus. Perhaps.

Just as likely, though, it’s a trial balloon to see what markets make of less BOJ stimulus. It also could be Kuroda’s way of placating hawks worried ultraloose policies are warping markets irreparably. That includes regional banks clamoring for higher long-term rates to boost margins.

But if the BOJ is plotting big changes, it must act more carefully and cooperatively than the Federal Reserve did in in 2013. That “taper tantrum” slammed emerging markets from India to Brazil to Turkey.

Repercussions

In Japan itself, government bonds are the main financial asset held by banks, pensions, insurance companies, the postal system, universities, endowments and the fast-growing ranks of retirees. Anything that provokes Japan’s $10 trillion-plus JGB monster would shake Asia’s No. 2 economy.

Globally, there’s the so-called “yen-carry trade” to consider. It’s become an axiom over the last 15 years that much of the liquidity driving markets derives from Japan.

Investors borrow cheaply in yen and redeploy that cash in higher-yielding assets from New Zealand to Canada. Any upward spike in the yen or JGB yields unleashes waves of deleveraging that slams world markets.

Even so, Kuroda doesn’t appear ready to institute radical changes. Perhaps the odd shift in focus from, say, managing 10-year yields back to focusing on the five-year vicinity of the yield curve. But don’t change those holiday-season plans just yet.