BOJ to Conduct More Bond Purchase Operations to Stem Volatility
Comment of the Day

May 30 2013

Commentary by Eoin Treacy

BOJ to Conduct More Bond Purchase Operations to Stem Volatility

This article by Toru Fujioka and Masahiro Hidaka for Bloomberg may be of interest to subscribers. Here is a section
“The BOJ dominates asset markets for better or worse,” Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., said in a post on Twitter. “Watch JGBs, the yen and the exodus from each.”

Japan's outstanding debt was 991.6 trillion yen at the end of March, a ministry report showed this month. It's projected to reach 245 percent of gross domestic product this year, according to an International Monetary Fund estimate, the highest ratio in the world.

Minutes released this week of the BOJ's April 26 meeting showed divisions on the policy board, where “a few” members see difficulties meeting a 2 percent price goal by the end of March 2016. One member said the bond market could become unstable again, while others said that swings in financial markets had been triggered by perceptions that the BOJ had conflicting goals -- trying to push down interest rates while pursuing inflation.

There are no signs investors have “excessively bullish expectations,” Kuroda said in Tokyo on May 26. He cited an April BOJ report indicating rates could rise by between one and three percentage points in an improving economy without causing financial instability. In parliament today, he said he sought to reduce volatility to make the central bank's policy effective.

Kuroda's BOJ has shown it will step into bond markets to stem volatility. When JGB yields touched 1 percent on May 23 and a plunge in bond futures set off a circuit breaker on the stock exchange, the central bank supplied 2 trillion yen to the financial system, its second such market-calming infusion this month.

Eoin Treacy's view Japan has succeeded in devaluing the Yen over the last six months and has not received criticism of its policies from its trading partners. This suggests widespread acceptance of the country's efforts to break the deflationary cycle in conjunction with a commitment to introduce economic reforms. However, as the process of weakening the currency progresses and other currencies strengthen on a relative basis, the pace of the decline is likely to moderate further.

The Yen Trade Weighted Index dropped abruptly from 150 to 110 from August 2012. This Index last traded near this level in 2008 and the 110 area had been a previous area of resistance between 2004 and 2008. It may offer support now. A short-term oversold condition is evident following the swift decline and potential for a bounce has increased. A break in the progression of lower rally highs, currently near 118 would confirm more than a temporary pause in the medium-term downtrend.

In nominal terms, Japan has been one of the best performing stock markets this year; helped in no small part by the devaluation of the currency. The Nikkei 225 doubled in less than a year but encountered resistance in the region of 16,000 last week to form a large downside weekly key reversal. It has followed through to the downside this week and has now unwound more than half its overbought condition relative to the 200-day MA.

The Topix Bank Index outperformed the wider market from June 2011 and the pace of its advance picked up from December 2012. It fell to break the short-term progression of higher reaction lows two weeks ago and has now unwound this year's entire relative advance. The 0.145 area may offer an area of support but an upward dynamic will be needed to confirm a return to financial sector outperformance. Since the banking sector led on the way up and during the current correction, there is a high probability it will also lead the wider market when this corrective phase has run its course. (Also see Comment of the May 23rd)

The Topix Real Estate Index ratio has a similar pattern. In absolute terms, it has unwound the accelerated portion of its advance and has returned to test the progression of higher reaction lows which may offer an area of support. An upward dynamic will be required to confirm the return of demand in this area.

JGB 10-year yields pulled back from the psychological 1% level last week following BoJ intervention but continue to hold above the 200-day MA, currently near 0.73%. Despite the potential for additional central bank purchases, the administration's outright inflationary bias suggests JGBs are unlikely to represent a favourable investment proposition over the medium term.

The Topix 2nd Section Index's reaction has so far been relatively similar sized to that posted in April. However an upward dynamic would be required to check potential for a deeper process of mean reversion. The TSE Mothers Index encountered resistance in the region of 1000 earlier this month and is also consolidating its overextension relative to the MA. The Jasdaq Index has a relatively similar pattern.

Considering the fireworks which have taken the Japanese market by storm this year and the speed of the decline over the last week, assuming the above indices find support within the next few weeks, a period of consolidation is probably warranted before an additional advance can be supported.

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