Banks Emerge as Winners From BOJ With Bonds, Yen Erasing Losses
Comment of the Day

September 21 2016

Commentary by Eoin Treacy

Banks Emerge as Winners From BOJ With Bonds, Yen Erasing Losses

This article by James Regan and Kelly Gilblom for Bloomberg may be of interest to subscribers. Here is a section:

The BOJ plans to maintain 10-year yields in the nation at around the current level of close to zero, it said Wednesday, giving it scope to keep loosening policy to revive growth and inflation, while limiting the negative impact on financial companies’ earnings. The BOJ faced a backlash after first deploying negative rates in January, with Governor Haruhiko Kuroda acknowledging it cut into the profits of lenders and insurers by driving long-term yields lower. Next, investors will be looking to the U.S. for any signals regarding the timing and pace of future Fed hikes, with all but four of 102 economists surveyed by Bloomberg predicting policy makers will hold off from raising interest rates.
“Central banks are acknowledging that excessively negative rates are damaging to bank profitability,” said Michael Hewson, a market analyst at CMC Markets in London. “There is a perception that maybe what the Bank of Japan is looking to do could be a template for the European Central Bank and potentially the Bank of England.”

Monetary authorities will continue to command attention on Thursday with speeches due from the new governor of the Reserve Bank of Australia as well as the heads of the European Central Bank and the Bank of England. In addition, central banks in countries including New Zealand, Norway and South Africa have policy decisions due that day.

Eoin Treacy's view

The Topix Banks Index collapsed in January following the announcement of negative rates. While we might look back in a few years and wonder what on earth central banks were thinking, it is now increasingly evident that they are beginning to accept it is a bad idea. Negative rates represent a major headwind for bank profitability and are inherently deflationary, which is the exact opposite of the long-term objectives of central bank policy 

Today’s news that the BoJ is going to target the yield curve would appear to be code that they are going to hold the 10-year yield close to zero. However the market is likely to test that commitment since it would require the central bank to sell bonds in order to achieve it. Considering how much debt is outstanding in Japan, the last thing they want is a spike in yields so the BoJ has a tricky time ahead I suspect. 

What does not appear to have been discussed is what happens if this new policy of “targeting the yield curve” fails to revitalise bank profitability or stoke inflation. After all it amounts to an announcement that current policies will be sustained, so not much of a change overall, which helps to explain why both the Yen rallied and bond yields compressed today.   

The Banks Index has spent much of this year ranging above 120, in what has been a gradual support building phase. It is now testing the region of the trend mean and a sustained move above it will be required to signal a return to demand dominance beyond short-term steadying. 

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