What is the Bank of Japan to Do?

The Bank of Japan is unlikely to change policy.  Its current
policy of targeting 10-year bond yields and expanding the balance sheet by
JPY80 trillion is aimed at boosting core inflation to 2%.  

However, the risk is that BOJ Governor Kuroda surprises the market as he
has done on other occasions.
  If
Kuroda is going to surprise the market, what would it take? 

There are several moving parts.  First, the BOJ currently
forecasts core CPI, by which it means consumer prices excluding fresh food,
will rise 1.5% this fiscal year.   This
is highly unlikely, erring on the side of
hope over analysis.  The core rate stood at 0.2% in February and is
expected to have remained there in March, which will be reported before the weekend.   It could bring it toward the
market expectations.  The Bloomberg survey puts it at 0.7% this
year.  Second, the BOJ could push out when it expects to achieve its
target, which now looks to be the end of the next fiscal year–in two years’ time.  

Both of these measures would likely signal an extension of the unorthodox
policies.
  This leads to a third
step the BOJ could take.  Many in the market see that the BOJ unlikely by JPY80 trillion of government bonds this
fiscal year.   On the one hand,
the shift toward targeting the 10-year yield has required fewer purchases that previously.  The pace
of BOJ bond buying has slowed.  On the other hand, estimates suggest that
as much around JPY40 trillion in government paper it owns will mature.  It
could announce a cut in its the overall
JGB purchases.  

Fourth, the BOJ could raise its
growth forecast.
  Last week Kuroda acknowledged that the economy was
stronger than anticipated a few months ago.  Exports have been strong, and this has helped spur industrial
production and capital expenditure.  Household consumption remains in the doldrums.  


Nevertheless, there is no hurry and Kuroda may surprise by doing
nothing. 
Steady as she goes may be the best course.  Despite the recovery
in European and US bond yields, the 10-year JGB is steady around
zero.   The upside momentum of the yen against the dollar, euro, and
sterling has stalled and partly reversed.  Investor seems particularly attuned to signs of an exit.  A combination, for example, is increasing the growth forecast and reducing
the amount of JGBs that will be purchased,
would likely be seen as tapering and could drive the yen higher.  

Our discussions with BOJ officials last month made it clear that Japan’s
central bank will be slow to change its
path.
  It wants to lag behind the other major central banks. 
Officials are committed to the 2% inflation target and are unlikely to abandon
it.  It does not want to risk investors misinterpreting its
intent.    The BOJ does not want to draw special attention to itself and must be pleased that after spending
about two weeks below JPY110, the dollar has resurfaced above it.  
The JPY11.80-JPY112.20 offers a band of resistance
(congestion and retracement objectives).  On a longer-term basis, a
convincing move above JPY112 could project toward
JPY114.-JPY115.00.  

Japanese equities are the worst performing of the G7 equity markets thus far
this year.
  The Topix is up 1.25%, and
the Nikkei is up a smidgen less than 1%. 
The pullback in the yen bodes well for Japanese equities.  The correlation
between the (percent) change of the dollar-yen
and Japanese entries is rising (now
~0.45).  The correlation with US stocks is rising but lower than with
Japanese shares over the past 30 and 60 sessions
(~0.38).  

The strongest correlation is between the dollar-yen and US 10-year
Treasury yields.
  The correlation over the past 60 days stands above
0.80, which makes it among the tightest correlation at least since 1990.  

Disclaimer

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