JP: The impact of QQE2 7 November 214 Economics Japan: The impact of QQE2 DBS Group Research 7 November 214 The BOJ will expand its quantitative and qualitative (QQE) program The yen has fallen and the Nikkei has risen, which is expected to boost growth and inflation in coming months The impact is more psychological than substantial. Real economy effects will be short-lived Elsewhere in the region, Korea is concerned about the yen s fall. Pressure will mount for the BOK to ease policy Capital flows from Japan to other parts of the region are expected to increase in the long term, not the short term The Bank of Japan (BOJ) announced an expansion of its quantitative and qualitative easing program (QQE) on 31 Oct. The annual pace of base money expansion will accelerate to JPY 8trn from JPY 6-7trn. To achieve this, the purchases of Japanese government bonds (JGBs) will increase to JPY 8trn per annual from JPY 5trn. The buying of ETFs and REITs will also increase to JPY 3trn (from 1trn) and JPY 9bn (from 3bn) respectively (Chart 1). In addition, the BOJ will further extend the average remaining maturity of JGB holdings, from 7 years to 7-1 years. Psychological impact is large Financial markets have reacted strongly to the announced change. The yen has depreciated by 5% against the US dollar since 31Oct. The Nikkei has surged 8%. Long term JGB yields have fallen, primarily in the 2Y-3Y space (8-15bps). Chart 1: The BOJ's annual pace of QE 9 8 7 6 5 4 3 Purchases of JGBs Purchases of ETFs & REITs Others 6-7 8 Chart 2: The GPIF's asset allocation target 1% 9% 8% 7% 6% 5% 4% 3% Domestic bonds Domestic stocks Foreign bonds Foreign stocks 2 2% Others 1 1% -1 Old New % Old New Ma Tieying (65) 6878-248 matieying@dbs.com 1
JP: The impact of QQE2 7 November 214 The BOJ s policy easing has created strong psychological impacts. It came right after the Fed s announcement of ending QE3, reinforcing the perception of a divergence in Japan s and US s monetary policy, hence putting downward pressures on the yen/dollar rate. It was accompanied by the Government Pension Investment Fund (GPIF) s announcement that it would reallocate its investment portfolio towards risky assets, amplifying the impact in the stock market. The GPIF, which manages a total of JPY 13trn assets, will cut the share of JGB holdings to 35% from 6% over the next five years and boost domestic equity holdings to 25% from 12%. The proportion of assets allocated to foreign equities and bonds will also increase, respectively, to 25% (from 12%) and 15% (from 11%, Chart 2). Real effects should be small The real effect of BOJ easing is likely to be far smaller than the short-term psychological impact. Base money has already expanded by JPY 6trn in 213 when the QQE program was firstly introduced and is estimated to expand further by JPY 7trn this year. Boosting monetary base by another JPY 8trn represents a small increase of JPY 1trn (Chart 3). The increase of the BOJ s asset purchases will be concentrated in the JGBs. About 2% of JGBs are currently held by the central bank, significantly higher than 1% held in 212. This should rise to 4% in 216 based on the BOJ s new pace of bond purchases (Chart 4). By squeezing out private investors in the bond market, the BOJ hopes that banks and other financial institutions will take more lending risk. This may or may not occur. The BOJ has already boosted its holdings of government securities by as much as JPY 116trn during Dec12-Sep14 since it established the QQE program. Banks, however, continued to accumulate cash reserves instead of lending. The outstanding balance of current deposits placed by all financial institutions at the BOJ has grown linearly over the past 21 months, by JPY 114trn (Chart 5). In terms of the BOJ s direct buying of risky assets, it will remain small. Annual purchases of ETFs and REITs will be lifted by JPY 2.6trn to JPY 3.9trn, a negligible amount compared to the market cap of the Tokyo Stock Exchange (JPY 48trn). Even combined with GPIF equity purchases, the impact on the stock market will not be signficant. The GPIF, in fact, has already been adjusting its portfolio over the past two years. The share of domestic equities in its portfolio has risen to 17% in Jun14 from 13% Chart 3: The size of monetary base 36 33 3 27 24 21 18 15 12 9 21: +4trn 211: +16trn New pace of QE Old pace of QE 212: +13trn 213: +63trn 214: +73trn 6 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 215: +8trn 2
JP: The impact of QQE2 7 November 214 Chart 4: The BOJ's holdings of JGBs % of total JGBs 5 45 New pace of QE Old pace of QE 4 35 3 25 2 15 1 5 21 211 212 213 214 215 216 Chart 5: The BOJ's balance sheet 24 Assets: Govt securities Liabilities: Current deposits 2 16 12 8 4 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 in Dec12. To achieve the new asset allocation target, the GPIF is estimated to boost the holdings of Japanese equities by about JPY 1trn over the next five years, a small increase of JPY 2trn per year. The yen Another question concerns the yen. Base money as a percentage of Japanese GDP, which has doubled to 56% from 28% at end-212, will rise further to 9% in 216 based on the BOJ s new pace of QQE. This stands in stark contrast with the base money-to-gdp ratio in the US, at 23% (Chart 6). On the surface, the widening of the base money gap points to depreciation of the yen against the dollar. For base money expansion to impact the currency, a decline in interest rates is required. But bond yields are already extremely low across the curve in Japan. The spreads between the long-term UST and JGB yields, which highly correlate with the USD/JPY, have remained largely unchanged since the BOJ s easing (Chart 7). A widening of the spreads, going forward, is more likely to be driven by a rise in the UST yields than by a decline in the JGB yields. Chart 6: Monetary base: Japan vs. US % of GDP 9 8 JP US 7 6 5 4 3 2 1 28 21 212 214 216 Chart 7: UST-JGB yield spreads vs. USD/JPY 115 15 95 85 USD/JPY 1Y yield spread (RHS) 3Y (RHS) 75 Jan-8 Jan-1 Jan-12 Jan-14 bps 32 28 24 2 16 12 8 4 3
JP: The impact of QQE2 7 November 214 Boost to the real economy will be short-lived Rising equity prices and a falling yen can benefit the real economy in the short term through lifting consumer sentiment and boosting exporters revenues. According to last year s experiences, the positive impact on economic growth through the financial market channel will only be temporary. GDP growth rose to 4.3% (QoQ saar) in 1H13, but fell back quickly to.7% in 2H13 (Chart 8). Structural headwinds and fiscal constraints will continue to weigh on the economy. Over the past two years, the depreciation of the yen failed to lift export volumes and industrial output proportionately. This could only be explained by structural factors, i.e., a high overseas production ratio of Japanese manufacturers and the continuation of their production relocation to emerging markets. Fiscal policy is also a constraint on economic growth. Fiscal policy has been tightened this year following the sales tax hike to 8% from 5%. The government has not decided yet whether to proceed with the second tax hike to 1% in 215. Under all the possible scenarios the hike is implemented, with or without a supplementary budget, or the hike is postponed fiscal policy in 215 will be neutral at best. If history is any guide, GDP growth could rise to 4% in the next 1-2 quarters before falling back to 1%. Barring further declines in oil prices, CPI inflation (adjusted by the sales tax) would be underpinned at the 1% level for another 3-6 months, before falling in mid-215. Regional impacts The BOJ s easing will also have repercussions on the region. The resumed depreciation of the yen refuels concerns about competitive currency devaluation. The countries that compete intensively with Japan in the export market South Korea in particular will pay close attention to their currencies vis-a-vis the yen. The Bank of Korea has cut interest rates twice this year, placing the policy priority on supporting economic growth. A sharp rise in the won versus the yen, were it accompanied by lackluster exports, would pressure the BOK to cut interest rates further. In the longer-term, trade competitiveness will be primarily determined by fundamental factors, such as productivity and technology. The role of exchange rate movements, especially in the medium-term, shouldn t be exaggerated (see Asia s export race: who s winning? 3 Oct). Many are also asking whether the BOJ s QQE expansion might lead to capital flows from Japan to other parts of the region. In fact, Japan was a net seller of Chart 8: Japan's GDP growth % QoQ saar 8 6 4 2-2 -4 Chart 9: Japan's outward portfolio investment 1 5-5 -1-15 Inflows Debt securities Equities Total Jan- Aug14-6 -8 1Q12 3Q12 1Q13 3Q13 1Q14-2 -25 Outflows 25 27 29 211 213 4
JP: The impact of QQE2 7 November 214 foreign equities and bonds in 213 after the launch of the QQE program (Chart 9). The outperformance of the Nikkei kept Japanese investors in the domestic market. And the sharp depreciation of the yen prompted them to sell foreign assets in order to convert the proceeds into yen. The home bias of Japanese investors will likely remain strong in the near term, given that the ongoing movements in the Nikkei and the JPY are similar to 213. A rise in Japan s capital outflows could be a longer-term story, determined by the negative growth and interest rate differentials between Japan and the rest of the world. The implications of the GPIF s asset reallocation on regional / global markets are relatively straightforward. The GPIF currently holds 16% of its JPY 13trn assets in foreign equities and 11% in foreign bonds. Based on the new asset allocation target, the GPIF s investment in foreign equities and bonds will increase by JPY 12trn and JPY 5trn over the next five years. Markets with relatively strong growth prospects and high yields should be able to absorb the funds flows from Japan without difficulty. 5
JP: The impact of QQE2 7 November 214 Recent Research CN: Significant easing remains unlikely 5 Nov 14 Asia export race: Who s winning? 3 Oct 14 ID: Watching external debt 3 Oct 14 MY: Assessing the GST impact 29 Oct 14 IN: Reviving manufacturing 28 Oct 14 HK-ASEAN trade prospects 24 Oct 14 JP: Policy intentions lack clarity 24 Oct 14 HK: Initial impact of Occupy Central 16 Oct 14 SG: Growth struggles continue 14 Oct 14 IN: Inflation and shifting policy dynamics 1 Oct 14 KR: Weakness exaggerated 9 Oct 14 EZ: Rates are firmly anchored 9 Oct 14 SG: Restructuring pain 8 Oct 14 CN: Price deregulation in motion 25 Sep 14 TH: Stronger consumption is key 24 Sep 14 US: The water rate addendum 23 Sep 14 IN: Forging global ties 19 Sep 14 US Fed: The water rate 16 Sep 14 Qtrly: Economics-Markets-Strategy 4Q14 11 Sep 14 IN: Market too dovish on 3M rate, 2Y fwd 25 Aug 14 KR: Housing recovery 21 Aug 14 IN: Increasing resilience 2 Aug 14 ID: Beyond 214 8 Aug 14 CN: SOE reform challenges 6 Aug 14 Asia cylical dashboard: EU disappoints 25 Jul 14 US: the inflation non-problem 23 Jul 14 SG: Downgraded 23 Jul 14 KR: Unleashing services 17 Jul 14 US: The search for a new policy rate 14 Jul 14 I n d i a b u d g e t : h i t s a n d m i s s e s 1 1 J u l 1 4 UST: 1Y yields downside limited 8 Jul 14 India budget: setting its sights longer 3 Jul 14 ID: Fiscal prudence still warranted 2 Jul 14 JP: Abe s reform plan, V2. 27 Jun 14 MY: Foot on the brake 27 Jun 14 Qtrly: Economics-Markets-Strategy 3Q14 12 Jun 14 CNH: Offshore loans set to grow 4 Jun 14 JP: Looking beyond the volatility 3 May 14 CN: In search of a new consensus 3 May 14 SG: On liquidity and property 3 May 14 TH: more downgrades 23 May 14 SG: SGD unappreciated 22 May 14 India elections: Quick review 16 May 14 IN: Four key post-election priorities 9 May 14 Asia: Gamechangers 5 May 14 CN: Consumption opportunities in the 28 Apr 14 rebalancing process SG: Competitiveness matters 23 Apr 14 EZ: Time to bite the QE bullet? 22 Apr 14 ID: The to-do list 21 Apr 14 Disclaimer: The information herein is published by DBS Bank Ltd (the Company ). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. 6