After $150 Billion Buying Binge, "Tokyo Whale" Seen Paring Back ETF Purchases In 2018

A few months ago, we noted that the Bank of Japan had decided to throw every textbook out of the window and crank their plunge-protection to "11"after reports surfaced that they owned a staggering 75% of Japan"s ETFs.

The BOJ first started their buying spree in December 2010 - when they held no ETFs at all - and have since accumulated some $150 billion in aggregate holdings.  The buying was all as part of unprecedented "economic stimulus" which has undoubtedly contributed to the Nikkei 225 Stock Average surging roughly 125% since December 2010.

Here"s a quick graphical recap of the program courtesy of Bloomberg...

...and another look which shows the central bank owns three quarters of ETFs by market value...

 

...all of which has resulted in the following bubble stock market appreciation...

Not surprisingly, since the program started, everyone from the head of the country’s stock exchange to the chairman of the Japanese Bankers Association has questioned the ETF program’s size and whether it artificially depresses volatility.

Now, with the Nikkei surging to 25 year highs, analysts are increasingly saying it"s time for the BOJ to put this specific component of their many controversial bubble-blowing policies to rest.  Per Bloomberg:

Sometime next year, the BOJ will cut its annual buying target for domestic exchange-traded funds by as much as a third from the current 6 trillion yen ($53 billion), says Toru Ibayashi, head of Japanese equities at UBS Wealth Management in Tokyo. Soichiro Monji of Daiwa SB Investments Ltd. expects a similar reduction, but by the end of March.

 

“Four trillion yen,” UBS’s Ibayashi predicted. “And everybody will understand.”

 

"Fear of deflation was behind the 6 trillion yen target,” Daiwa SB’s Monji said in an interview. “We’re no longer in that kind of environment. Risks are now skewed toward the upside, rather than the downside. It’s hard for the central bank to justify its buying spree.”

 

“Given the circumstances at this point in time, it is difficult for the BOJ to keep buying ETFs at six trillion yen per year,” Ibayashi said.

Jonathan Garner, chief Asia and emerging markets equity strategist at Morgan Stanley in Hong Kong, described the ETF purchases as “perhaps the most controversial part” of the bank’s stimulus program which includes everything from negative interest rates and yield-curve control to buying tens of trillions of yen of bonds each year, on top of its stock purchases. 

Of course, not everyone agrees as Naoki Kamiyama, chief strategist for Nikko Asset Management Co. in Tokyo, and Hisao Matsuura, a strategist at Nomura Holdings Inc., both saying the BOJ won’t cut its ETF target anytime soon as "it would hurt investor confidence and make a pickup in inflation much less likely..."

You know, because every central bank"s primary objective is to boost "investor confidence" by creating massive asset bubbles that make the masses feel richer...at least until the marginal stimulus fails and the whole ponzi comes crashing down...

WeWork: London"s Soon-To-Be Biggest Property Renter Makes Massive Bet On Office Market Despite Brexit

The rationale for creating WeWork, the eco-friendly serviced workspace provider, was simple as co-founder Adam Neumann explained to the New York Daily News.

“During the economic crises, there were these empty buildings and these people freelancing or starting companies. I knew there was a way to match the two. What separates us, though, is community.”

It wasn’t a bad idea since the company was recently valued at $20 billion. The first WeWork location was established in New York’s fashionable SoHo district (above) in 2010. Only four years later, Wikipedia notes that WeWork was the “fastest growing lessee of new office space in New York”. The company currently manages office space in 23 cities across the United States and in 21 other countries including China, Hong Kong, India, Japan, France, Germany and the UK.

WeWork’s growth has been little short of stratospheric, and investors have included heavyweight financial names such as JP Morgan. T. Rowe Price, Goldman, Wellington Management and Softbank. As Bloomberg reports, WeWork is about to repeat its success in New York and other cities by becoming the largest private lessee of office space in London. However, some old-school property developers are predicting that WeWork’s break-neck expansion is ill-timed.

A seven-year-old U.S. startup is set to become the biggest private tenant in London just as the U.K.’s economic outlook worsens. Three years after entering the British capital, WeWork Cos. has signed leases that will make it the city’s No. 1 private-sector user of office space, according to data compiled by CoStar Group Inc. for Bloomberg. The rapid growth makes WeWork, valued at $20 billion, increasingly important to the health of the city’s property market as well as more vulnerable to any future decline in rents.

“A downturn of some description has to happen at some point, and when it does the serviced office business will suffer very quickly,” said Michael Marx, the veteran developer who ran Development Securities Plc for 21 years through 2015. “In the present uncertain market many people are hoping that the WeWork model works -- but we have no idea whether it does on a sustainable basis or for how long. It appears to be a well-capitalized business, but if the cycle turns down, then the model looks vulnerable.”

As the chart below shows, WeWork’s expansion is occurring after the bull market in London office space is more than two decades into an upturn.

The company currently has 17 locations in London, with two more about to be opened, as shown on this map of the city. The majority of the office space is in the eastern part of the city, in and around the City of London.

The addition of the two about-to-open properties and another ten in the planning stage - one of which is the 620,000 square foot 12-building campus of Devonshire Square which the company is negotiating to buy outright from Blackstone Group (for $785 million) - will catapult WeWork into the number one position in London.

In short, WeWork is making a massive bet on the office market in London in spite of the risks posed by Brexit. From accounts filed by WeWork’s UK business, Bloomberg learned that the company has committed to £815 million ($1.09 billion) of rent payments in the future, of which £231 million ($309 million) is due over the next five years. Income in 2016 was £61 million ($81.7 million) and the company posted a loss of £11.1 million. Some anecdotal evidence unearthed by Bloomberg raises concern.

WeWork’s most basic membership plan, which allows access to the company’s offices two days a month and use of the firm’s app, starts at $45 a month, according to its website. The company ran a promotion this summer offering tenants half of their lease for free in an attempt to fill that space. In some cases, it has also paid brokers fees of as much as 20 percent for bringing in tenants, double the industry norm, people with knowledge of the matter said. WeWork’s standard broker payment is 10 percent, another person said.

WeWork is exposing itself to a classic case of liquidity mismatch. This is normally associated with the banking sector and banks being caught out in a crisis from borrowing short to lend long. In the property sector, the equivalent is borrowing long to rent short. Bloomberg reports the contrasting view of one of WeWork’s competitors, which shuns this strategy.

Jamie Hopkins, CEO of WeWork competitor Workspace Group Plc, said he prefers a business based on purchasing the properties the company rents out as short-term offices. “Buying long-term leases and selling short ones at a profit is not a model we are comfortable with at all,” Hopkins said in an interview. Owning its buildings gives Workspace “much more flexibility in terms of pricing if we need it,” he said.

Not surprisingly, WeWork sees things differently and Bloomberg relays its take.

While the company has acknowledged that Brexit poses economic risks, it also said that uncertainty surrounding the move will support its business as companies remain wary of long-term commitments. WeWork has secured deals with firms including International Business Machines Corp. and Amazon.com Inc. in its U.S. business and is seeking similar deals with blue-chip tenants in London.

Some companies have as many as 600 people in WeWork sites, McKelvey, the chief creative officer, told Bloomberg in an interview in July. “Our approach appeals to companies of all shapes and sizes,” he said, discussing a plan to expand rapidly in Latin America. The chief creative officer also described WeWork’s approach to growing quickly.

“To build out locations is a challenge,” he said. “But we came out with a very sophisticated platform of how we manage that whole process and it allows us to run it like a software development process, and it gives us a lot of confidence in our ability to execute.”

In WeWork’s defence, Softbank invested $4.4 billion in the company, which is what established the $20 billion valuation. While that is reassuring, the story behind Softbank’s investment is bizarre and doesn’t inspire confidence in WeWork’s prospects.

Before the deal was announced SoftBank Vice Chairman Ron Fisher -- who led the investment -- met with executives at IWG Plc, a competitor with a much lower valuation and more than 10 times as many sites, people with direct knowledge of the matter said. The meeting was held to better understand the temporary office business model and address the investor’s concerns over WeWork’s valuation, they said.

IWG, in its former incarnation as Regus, filed for bankruptcy protection for its U.S. business in 2003 after it expanded too rapidly in the dot-com boom. IWG has a market value of just 1.8 billion pounds despite having nearly 3,000 locations worldwide compared to WeWork’s 235. More recently, the Swiss company has seen the value of its shares drop almost 40 percent since Oct. 19 when it issued a profit warning, citing in part weakness in the London market.

IWG is “the same business, the returns are the same and there is no difference -- there’s no alchemy in it,” CEO Mark Dixon said in an interview about half-year earnings, comparing his company to WeWork.

Some old hands in UK real estate are pointing out how WeWork’s expansion across London is merely transferring risk, not reducing it. Indeed, by bidding up for office space, WeWork is taking on the risk previously in the hands of landlords, since it needs to rent out the office space. The CEO of the UK’s largest REIT, Land Securities, noted “You are effectively transferring risk from a landlord to an intermediary, that space still needs to be let out.”

Meanwhile, the jury on WeWork’s rapid late-cycle expansion is still out and we sympathise with the tone of the feedback reported by Bloomberg. Either WeWork is going to blow-up, or it’s the work of genius. If  pushed, we’d probably side with the former.

Despite the risks, WeWork has its backers in the London property market. “I hear people say it is going to blow up any minute now, but they have got major investors,” Tony Gibbon, founder of broker GM Real Estate said at the Bisnow event. “People question the valuation but so what, it is a considerable scale and it is a trend that isn’t going to disappear.”

“There are clearly risks associated with the speed of expansion of WeWork,” Toby Courtauld, CEO of London office landlord Great Portland Estates Plc, said in an interview. “It is probably too early to call whether that’s a systemic problem or in fact is a fantastic call by them.”

More Evidence BoJ Desperate To Steepen Yield Curve

Two days ago, we highlighted how Bank of Japan officials have been briefing Reuters about reducing its monetary stimulus earlier than markets had been expecting – around 1Q 2018 rather than later in the year. In particular, the yield curve control (YCC) is likely to be eased from the current target of zero percent for 10-year JGB yields. It seems the BoJ became frustrated that markets had failed to respond to his hints about the “reversal rate”, i.e. that central banks can lower rates too far and damage financial institutions and the provision of credit in the economy. The one (former) BoJ official who was prepared to go on the record explained.

“Reversal rate is a pretty shocking word to come out of the mouth of a BOJ governor. It’s unthinkable the BOJ would insert it in Kuroda’s speech without any policy intention,” said Takahide Kiuchi, who was a BOJ board member until July.

 

The BOJ may allow long-term rates to rise more by shifting its long-term rate target to five-year yields from 10-year yields around the first quarter of next year, Kiuchi said. “The BOJ could put a positive spin on the move by saying it can more effectively reflate growth by keeping short-term borrowing costs low while allowing longer yields to rise.”

We might assume that the BoJ is becoming obsessed with steepening the yield curve and we got confirmation of this overnight. A story which flashed up on Bloomberg about the BoJ tapering bond purchases at the super long end.

BOJ Bond Cut Shows Desire to Steepen Yield Curve: Merrill Lynch

 

Bank of Japan’s slight cut in buying of bonds maturing in more than 25 years suggests its desire to steepen the yield curve, says Shuichi Obsaki, chief rates strategist for Japan at Bank of America Merrill Lynch.

 

Yield curve has been flattening of late and the BOJ is probably sending a message that it wants the super-long yield curve to steepen.

In terms of the mechanics, the BoJ today cut its purchases of bonds maturing in more than 25 years to 90 billion Yen from 100 billion yen at the previous offer on 17 November 2017. This was the first cut since March. JGB yields rose on the news in Friday trading, as Bloomberg reports.

JGB yields rose across the curve after the BOJ trimmed outright debt purchase in the super long sector.

 

BOJ reduced purchases of bonds with maturity of more than 25 years by 10b yen to 90b yen; it was the bank’s first cut in the sector since March.

 

Purchase volume for the 10-to-25-year zone was unchanged at 200b

 

JGB futures closed regular day down 0.13 at 151.02; key futures suffered the biggest intraday loss since Oct. 2, losing as much as 0.21

 

10-year cash bond yield rises 0.5bp to 0.025%; 20-year yield gains 1bp to 0.57%; 30-year climbs 2.5bps to 0.830%

 

Falls in JGB futures were exaggerated by sharp rise on Wednesday

It appears that the BoJ had become panicked by the yield curve flattening after reports that the government might reduce the issuance of super-long bonds in the next fiscal year, i.e. to March 2019. On Wednesday, there was a meeting between officials from Japan’s Ministry of Finance and primary dealers to discuss the plans for issuance in the next fiscal year.

While inflation is remains far below its 2% target, the BoJ is being forced into a policy reversal due to the damage its NIRP/ZIRP policy is doing to the financial sector. However, it’s portraying its defeat as  a victory via the supposed reflationary signalling of steepening yield curve. It’s utter nonsense and a shameful reflection on the depths which central bankers will stoop to.

Another One: Japan"s "Fake Data" Scandal Hits Mitsubishi Materials

So Kobe Steel was not an isolated incident and faking data on manufacturing quality in Japan is quite common, as other lower profile scandals at Nissan Motor and Takata proved. Today another culprit has come to light: Mitsubishi Materials – which may need to re-consider its corporate philosophy “For People, Society and the Earth” and Articles 2 and 3 of its code of conduct “Safety First” and “Compliance”.

The company has admitted to falsifying data on rubber seals, brass strips and aluminum products sold to more than 250 customers in the aerospace and auto sectors. Having hit a two year high earlier this month, Mitsubishi Materials’ share price plunged during the Tokyo trading session, closing 8.1% lower on the day at 3,760 Yen, having traded as low as 3,635 Yen.

More from Bloomberg:

Japan’s reputation for manufacturing prowess took another hit as Mitsubishi Materials Corp. admitted it faked data on some products just weeks after a similar scandal engulfed Kobe Steel Ltd. Buyers of Japanese industrial goods from Boeing Co. to Airbus SE were once again scrambling to confirm whether safety had been compromised after Mitsubishi Materials said three of its units had faked data on products that may have been delivered to more than 250 customers. Its shares plunged as much as 11 percent in Tokyo, the most in eighteen months.

Mitsubishi Cable Industries Ltd. falsified data on rubber seals, while Mitsubishi Shindoh Co. misreported the strength of brass strips for auto parts, according to a statement Thursday. The products may have been shipped to 229 Mitsubishi Cable clients and 29 customers of Mitsubishi Shindoh. A third unit, Mitsubishi Aluminum Co. Ltd., also supplied non-conforming products, although it has already confirmed with customers that they are safe, the company said, adding that its investigation hasn’t uncovered any cases that raise the possibility of legal violations or safety issues.

The number of scandals of this type is a growing embarrassment to Japan’s famed manufacturing excellence and quality control.

The revelation is the latest in a series of scandals to dent the image of Japanese manufacturers and closely resembles recent admissions by Kobe Steel that it falsified data on the strength and durability of its products. In the auto sector, Nissan Motor Co. has said it conducted vehicle inspections that didn’t comply with regulations for almost four decades, while Subaru Corp. allowed uncertified workers to inspect vehicles before shipment. Takata Corp. filed for bankruptcy earlier this year because of faulty airbags.

A disconcerting feature of the breaking scandal at Mitsubishi is that like recent "incidents" at Equifax and Uber, the company was aware of the fake data problem at its Mitsubishi Cable subsidiary in February 2017, but failed to halt shipments until last month.

Japanese Trade Minister Hiroshige Seko called the matter “extremely regrettable” at a briefing Friday, and said the ministry has asked related departments to investigate its causes and is seeking an explanation from Mitsubishi Cable on why it took so long to report its problem. He added that he considers it a matter for the companies and not an industry-wide issue.

According to the statement, Mitsubishi Cable uncovered the misconduct in February and stopped shipping non-conforming products on Oct. 23; the company told its parent two days later. Mitsubishi Shindoh found out about its problem in October and stopped shipments on Oct. 18, alerting Mitsubishi Materials the following day.

As the Financial Times reports, the falsification of data stretches back to 2015 at Mitsubishi Cable and Mitsubishi Shindoh has a joint venture with Kobe Steel.

Mitsubishi Materials said in a statement that its Mitsubishi Cable Industries unit had falsified data since April 2015 on the quality level of rubber O-rings, which are used to prevent leaks in aircraft, cars and other industrial equipment. Another subsidiary, Mitsubishi Shindoh, was found to have delivered metal products with quality levels below that claimed by the company or requested by customers.

Mitsubishi Materials has a 45 per cent stake in a copper tube venture with Kobe Steel, stemming from a partnership formed in 1999 alongside affiliate Mitsubishi Shindoh. That joint venture includes the Hatano plant south-west of Tokyo that has become the focal point of Kobe Steel’s data falsification scandal, and been subsequently stripped of numerous Japanese and international quality certifications.

Mitsubishi Cable employs around 500 workers and Mitsubishi Shindoh over 1,000 out of a group workforce of some 25,000. In the year to March 2,017, group sales were $11.6 billion and net profit $252 million. “Even if Mitsubishi Shindoh and Mitsubishi Cable don’t make up a big portion of the company’s earnings, not just the short-term impact, but the mid and long-term impact on its orders is a cause of concern,” Keiju Kurosaka, senior analyst at Mitsubishi UFJ Morgan Stanley Securities, told Bloomberg.

Naturally, when these "fake something" scandals relate to high precision engineering parts, attention immediately turns to the manufacturers of commercial aircraft. Airbus published a statement saying that it doesn’t directly procure parts from Mitsubishi Materials and is investigating its supply chain. Boeing said that it’s reviewing the matter. Whether it’s a precedent for Mitsubishi Materials, time will tell, but Bloomberg notes that none of Kobe Steel’s customers have reported a safety problem so far.

Kobe Steel’s crisis erupted in early October, collapsing its shares. Although 525 customers were affected, none has yet to report safety issues and no products have been recalled, allowing its stock to recover some of its losses. As of last week, shipments to 484 clients had been given the all-clear.

Kobe blamed lax controls and too much focus on profit for its short-comings, including unrealistically high standards that exceeded clients’ expectations, which encouraged staff to disregard quality guidelines for a decade or more. The company was forced to abandon its profit forecasts and has lost quality assurance certification -- often demanded by customers as a condition of sale -- at seven of its 20 plants.

Mitsubishi Materials has to explain itself to the Japanese government by tonight. Transport Minister, Keiichi Ishii, stated that Mitsubishi Materials will report to his Ministry later on Friday with details on products and customers affected. He said that he will instruct the company to put the highest priority on safety…too late. We are nervously awaiting the next “revelation” on Japanese manufacturing.

BoJ Briefs Reuters: We"ll Let 10-Year Yield Rise Above Zero Percent Target Around 1Q 2018

It looks like BoJ Governor, Haruhiko Kuroda’s, minions are getting out and about to brief the financial news services that the biggest stimulator of all the central banks might reduce stimulus earlier than expected. The recipient of the unofficial briefings by BoJ officials is Reuters, which has this to say.

The Bank of Japan is dropping subtle, yet intentional, hints that it could edge away from crisis-mode stimulus earlier than expected, through a future hike in its yield target, according to people familiar with the central bank’s thinking.

With inflation still way below its 2 percent target, the BOJ sees no immediate need to withdraw stimulus, and regards weak price growth as its most pressing policy challenge. But bank officials are now more vocal on the rising cost of prolonged easing, such as the hit to bank margins - a sign that their next move would be to roll back stimulus rather than expand it, the people said.

It seems that BoJ has been sending signals – in particular by referring to the “reversal rate” - but some people weren’t paying attention.

The first sign of change came in Nagoya on Nov. 6, when BOJ Governor Haruhiko Kuroda - whose current term ends in April - said he was “mindful” of the risk prolonged easing could hurt banks’ appetite to lend. Days later, board member Yukitoshi Funo said the BOJ must be vigilant to the cost of easing. The most striking warning came from Kuroda last week, when he referred to a “reversal rate” - the level where rate cuts by a central bank hurt, not help, the economy by damaging banks and discouraging lending.

Kuroda gave a speech with the catchy title “Quantitative and Qualitative Monetary Easing and Economic Theory” at the University of Zurich on 13 November 2017. During the speech, in a section “Determining the Optimal Yield Curve”, he specifically referred to the reversal rate.

Another issue that has recently gained attention with regard to the impact on the functioning of financial intermediation is the "reversal rate." This refers to the possibility that if the central bank lowers interest rates too far, the banking sector"s capital constraint tightens through the decline in net interest margins, impairing financial institutions" intermediation function, so that the effects of monetary easing on the economy reverses and becomes contractionary. In Japan"s case, financial institutions have a solid capital base and credit costs have fallen sharply, so that at present their financial intermediation function is not impaired. However, because the impact of the low interest rate environment on financial institutions" soundness is cumulative, the Bank will continue to pay attention to this risk as well…Taking also various kinds of qualitative information into account, the Bank of Japan will continue to pursue the shape of the yield curve that is deemed most appropriate in order to maintain the momentum toward the 2 percent price stability target.

Okay, so we know Kuroda is focusing on the impact of the so-called reversal rate in the context of the yield curve. The unnamed BoJ officials spell it out to Reuters.

The most likely first step - albeit some time away - would be to allow long-term rates to rise more, reflecting improvements in the economy, they said. “The change in tone doesn’t have immediate policy implications, but it’s probably intentional,” one of the people said. “The BOJ wants to make its policy framework more sustainable,” said another. “Allowing longer-term rates to rise more would give banks some breathing space.”

We really should have paid more attention because Reuters implies (kind of) that referencing the reversal rate is central bank code for "we are preparing to reduce stimulus"…and the BoJ does like to drop hints.

European Central Bank (ECB) executive board member Benoit Coeure referred to the reversal rate in July last year in discussing when further rate cuts could become counter-productive. Five months later, the ECB decided to cut monthly asset purchases from 2017. The BOJ also has a history of dropping early hints of a future policy shift. Roughly a year before adopting its yield curve control (YCC) policy, the BOJ published a research paper analysing the feasibility of the idea.

In his speech “Assessing the implications of negative interest rates” at the Yale Financial Crisis Forum, Coeure noted.

it has been suggested that at some point the level of rates can become low to the extent that the detrimental effects on the banking sector outweigh the benefits of lower rates. In a recent paper, Brunnermeier and Koby refer to this rate as the “reversal rate”. At the reversal rate, bank profitability will fall, reducing capital generation via retained earnings, which is an important source of capital accumulation, and thereby eventually restricting lending.

Surpassing itself, Reuters “found” a BoJ board member, a former one anyway, who will speak on the record.

“Reversal rate is a pretty shocking word to come out of the mouth of a BOJ governor. It’s unthinkable the BOJ would insert it in Kuroda’s speech without any policy intention,” said Takahide Kiuchi, who was a BOJ board member until July.

 

The BOJ may allow long-term rates to rise more by shifting its long-term rate target to five-year yields from 10-year yields around the first quarter of next year, Kiuchi said. “The BOJ could put a positive spin on the move by saying it can more effectively reflate growth by keeping short-term borrowing costs low while allowing longer yields to rise.”

So there we have it…the BoJ is preparing to pull back on its obscene level of stimulus. Some time in the first quarter of 2018, or just after, the bank will adjust its Yield Curve Control (YCCC) policy, allowing the 10-year JGB yield to rise above the current zero percent target. Reuters explains.

The shift in communication comes as the U.S. Federal Reserve and ECB head for an exit from ultra-loose policy, and suggests the BOJ could follow suit sooner than expected. A majority of economists polled by Reuters before Kuroda’s latest comments expect the BOJ’s next move to be a withdrawal of stimulus - but not until later next year or beyond.

Just to make it really clear what’s happening, this was Reuters’ parting shot.

“It’s important the BOJ prepares markets in advance with careful communication,” said a third person familiar with the bank’s thinking.

Is this why the Yen is strengthening?

Sprint, T-Mobile Plunge: SoftBank Calling Off Merger

Sprint stock plunged, and was halted by the exchange volatility trigger, when the Nikkei reported moments ago that Japan"s SoftBank Group plans to break off negotiations on the long-awaited merger between its subsidiary Sprint and T-Mobile US due to a failure to agree on ownership of the combined entity, "dashing the Japanese technology giant"s hopes of reshaping the American wireless business."

According to The Nikkei, SoftBank is now expected to approach T-Mobile owner Deutsche Telekom as early as Tuesday to propose ending the negotiations. The pair had reached a broad agreement to integrate T-Mobile and Sprint - the third- and fourth-largest carriers in the U.S. - and were ironing out such details as the ownership ratio.

The German parent had insisted on a controlling stake, according to a source familiar with the situation. Some at SoftBank were initially amenable as long as the Japanese company retained some influence. But SoftBank"s board affirmed at a meeting Friday that the company would not give up control. The decision was made Monday to call the talks off.

Meanwhile, in the latest nightmare announcement for M&A arbs, Sprint tumbled as much as 13% before resuming, with TMobile also dumping, as it now appears that this endless merger process is finally dead.

Japan Is Booming! (Except It"s Not)

Authored by Jeffrey Snider via Alhambra Investment Partners,

Japan is hot, really hot. Stocks are up to level not seen since 1996 (Nikkei 225). Prime Minister Shinzo Abe called snap elections in Parliament to secure a supermajority and it worked. Things seem to be sparkling all over the place, with the arrow pointing up:

“Hopes for a global economic recovery and US shares’ strength are making fund managers generous on Japanese stocks,” said Chihiro Ohta, general manager of investment research at SMBC Nikko Securities.

Only that isn’t real, just like it wasn’t three or seven years ago. Emotions don’t seem to be tracking well with reality, and in Japan it is no different. There isn’t even much of lingering popular belief in QQE to at least give these broad feelings the appearance of substance; global growth is coming because, well, it just has to, right?

Like here, or anywhere for that matter, stocks are up but the economy is not. Belief still clings to what is always over the horizon. You would think given the breathless coverage in the worldwide media that Japan is utterly booming, jumping with so much activity the island can’t contain it all. It just isn’t true, the story being wildly distorted as always to fit the (technocrat friendly) narrative.

Household spending in Japan, for example, has turned slightly positive in the past few months. It sounds like more than it is, less of a positive than in the middle of 2015 when all the same things were being said about the subject by the same people. Like anywhere else, even the Japanese economy is prone to the occasional upturn. What really matters is that those brief moments of positive never come close to making up for the more widespread and sustained negatives.

It’s another relative change that is mistaken, quite often intentionally, for a categorical one. In other words, Japan is experiencing little more than a reprieve from continued contraction rather than any actual turn toward actual growth.

That verdict is given to us by Japan’s labor market. The more positive anyone is about the economic circumstances there, the more likely it is that the labor market shows the opposite. Total hours worked continue to decline despite the rise in relative activity (again, proving its relative not categorical).

Wages that had looked seemed like they were on the rise really were impacted more by base effects and statistical irregularities (the transitory rise, then fall, of the CPI) than anything tangible. Real wages have contracted year-over-year in each of the past three months, and have been zero or negative in ten of the last eleven. And still economists point to Japan’s unemployment rate as if it matters.

But because the media is selling the future of “global growth”, the charade will/can only continue:

A hefty win raises the likelihood that Abe, who took office in December 2012, will secure a third three-year term as LDP leader next September and go on to become Japan’s longest-serving premier. It also means his “Abenomics” growth strategy centered on the hyper-easy monetary policy will likely continue.

It’s the appearance of hyper-easy monetary policy, not actual or effective accommodation. No matter how many times the other is claimed and will be claimed, that doesn’t just make it true. In Japan, like everywhere else in the world, there isn’t the slightest hint that QE, QQE, or QQE with YCC underwrites even a little positive economic difference. Japan’s small upturn has nothing to do with QQE and everything to do with minor (and relative) “reflation” after the “rising dollar.”

At now more than half a quadrillion yen on its books, both sides assets and liabilities, obviously, what is the Bank of Japan’s QQE actually doing? It has been reduced to questionable histrionics, the necessary part of every media story on Japan that makes it seem like authorities are doing something helpful.

I believe instead that Abe’s successful election gambit is somewhat of a parallel to other political processes being played out in places like Austria, Germany, and even to some degree China. The Japanese people have resigned themselves to this economy as it really is, and pay very little attention to QQE or whatever else like it. They have to know by now that it has made no positive contribution, so why not vote on the basis of other matters if the grand economic designs that swept Abe into office the first time in 2012 can’t move the needle after five years.

Abenomics or not Abenomics, there has been no difference. The economy is as bad or worse than it was before, and it doesn’t look like either party will do anything that can change matters. Therefore, increasingly, other issues become the centerpiece for what is really economic dissatisfaction channeled into alternate formats.

Earlier this year, in the face of an increasingly hostile North Korea, Abe set a deadline of 2020 to revise Japan’s constitution, which contains language that bans the country from maintaining armed forces. It is a controversial proposal that strikes at the heart of the country’s post-war identity.

If that post-war identity includes hapless technocratic monetarism, then why not change it if only to be able to change something? Maybe the Japanese do have a limit, and that a quarter-century is more than enough of one feckless scheme after another. The old way of doing things just doesn’t work anymore, a judgment that is being applied all across the world. North Korean or Chinese provocations suddenly matter more now perhaps because the Japanese worry about Japanese strength in economic terms.

It’s almost political contagion, where people in Japan or the UK see others voting for “that’s enough” and want to make the same bold, dissenting statement however they might. You vote for something very big and very different because there is no vote on monetary or economic protest that either political party will give you. It explains quite a lot, including the backlash against the backlash.

The world is treading a dangerous path primarily because the official parts of it won’t admit there is a problem; or, in places like Japan, that they might not have the will and understanding to do anything about it. It’s the worst part of this zig zag, where nothing, even stagnation (depression), ever goes in a straight line. Each of these all-too-brief upturns are always mischaracterized as far more than they ever could be, and so any urgency about addressing the real issue falls by the wayside.

The growing unrest doesn’t, of course, and instead gets funneled into often unproductive directions. We collectively look in the wrong place because the right answers are really hard to see.

Kobe Steel Scandal Goes Nuclear: Company Faked Data For Decades, Had A "Fraud Manual"

Last week we reported that in the latest instance of criminal Japanese corporate malfeasance, Japan"s third-biggest steel producer admitted falsifying data about the quality of steel, aluminum, copper, iron powder and other products it sold to customers across virtually every single industry. The news sent the company"s stock tumbling 43% from levels before the scandal broke, to the lowest price since 2012.

The downstream impact was quickly felt, with selling hitting names across the global supply chain...

 

... while the NYT reported that the fallout has the potential to spread to hundreds of companies. As of a week ago, the extent of the problems at Kobe Steel was still unfolding, and prompte the Nikkei newspaper to conclude that "the falsification problem has become an issue that could destroy international faith in Japanese manufacturing."

Well, as of moments ago that tipping point was this much closer, when the same Nikkei reported that some Kobe Steel plants in Japan had been falsifying product quality data for decades, well beyond the roughly 10-year time frame given by the lying steelmaker. According to the Japanese newspaper, "employees involved in the data manipulation used the industry term tokusai to refer to shipping of products that did not meet the standards requested by customers", the Nikkei source said. Though tokusai usually refers to voluntary acceptance of such products, plants sometimes sent substandard goods without customers" consent. The word was apparently in use at some plants for 40 to 50 years.

But wait, it gets better.

Not only did the company, having already been caught, lie to shareholders and rule-abiding employees how long this illegal behavior had been going on, but - in a glaring example of corporate idiocy - had effectively enshrined and codified its fraudulent ways, as the cheating procedures eventually became institutionalized in what was essentially a tacit fraud manual, allowing the practice to continue as managers came and went.

Meanwhile, the Nikkei also reports that everyone could have been in on it, as data manipulation may have occurred with the knowledge of plant foremen and quality control managers. Some shipments even came with forged inspection certificates.

Kobe Steel has tapped senior officials in the aluminum and copper business - where most of the misconduct took place - to serve on its board. How far up the chain of command knowledge of the fraud may have extended in the past remains an open question.

According to the latest update, systemic data falsification took place at no less than four Japanese production sites and appears to have affected virtually every product made by the company: the scandal has spread to the manufacturer"s mainstay steel business, with revelations Friday that steel wire was also shipped without inspection or with faked certificates. Meanwhile, the number of affected customers has swelled from around 200 to roughly 500.

One can only imagine the "honesty", measured in alpha, beta and gamma radiation, if Kobe was also behind the Tepco nuclear disaster, where of course as we leaned over the past 6 years, the amount of data fabrication was just as unprecedented. It is almost as if there is something rather rotten with Japan"s entrenched, corporate ways...

But not to worry: in an amusing twist, Kobe Steel has promised it will complete safety inspections for already shipped products in two weeks or so. A report on the causes of the fraud and measures to prevent a recurrence will come out in a month or so; we can"t wait to read the lies in that one. The steelmaker is conducting a groupwide probe that includes interviews with former senior officials. Because if there is anything Kobe will be successful at, it is diligent, honest self-reporting.

Where the company is certainly lying however, is when it told analysts earlier on Monday that "liquidity is not an issue" according to Bloomberg. Judging by the explosion in Kobe Steel CDS in recent days...

... one more gaffe by the scandal-plagued company, and Kobe Steel will be insolvent. As for all those who are considering providing liquidity to this fraud of a company, good luck with lying to yourselves that you will ever see any of that money back.

Kobe Steel Collapses 37% After Admitting Falsifying Data: "Could Destroy International Faith In Japanese Manufacturing"

Japan"s third-biggest steel producer is in trouble. After admitting falsifying data about the quality of aluminum and copper it sold, shares in Kobe Steel have collapsed 37%,  -20% limit down yesterday and another -17% at the open today following news that the falsification also involved iron powder product, in the biggest bloodbath the company has ever seen.

Bloomberg provides a quick Q&A:

1. What exactly did Kobe Steel falsify?
Data related to the products’ strength and durability. Kobe Steel says it discovered the falsification in inspections on goods shipped in the 12 months through August, affecting some 4 percent of shipments of aluminum and copper parts as well as castings and forgings. As yet, the company, which employs about 37,000 people, says there have been no reports of safety issues.

2. Was this a rogue event?
Hardly. The fabrication of figures was found at all four of Kobe Steel’s local aluminum plants in conduct the company described as “systematic.” For some items, the practice dated back some 10 years ago, according to executive vice president Naoto Umehara. Details have yet to emerge.

3. What do its customers say?
Here’s a taster. Toyota is “rapidly working to identify which vehicle models might be subject to this situation and what components were used,” according to spokesman Takashi Ogawa. "We recognize that this breach of compliance principles on the part of a supplier is a grave issue.” Toyota found the materials in question in hoods and doors, as did Honda Motor Co. Boeing, which gets some parts from Kobe Steel customer Subaru Corp., said there’s nothing to date that raises any safety concerns. Hitachi Ltd. said trains it has exported to the U.K. contained compromised metal as well as bullet trains in Japan. Mazda Motor Corp. also confirmed it uses aluminum from the company, while Suzuki Motor Corp. and Mitsubishi Motors Corp. all said they were checking whether their vehicles are affected.

After yesterday"s limit down open (and no shift), today"s 17% plunge following a report in the Yomiuri newspaper that Kobe may also have fabricated data on iron powder products used typically in components such as automotive gears, the stock smashed back to 12 month lows (and erased $1.7bn of the company"s $4.5bn market cap as of Friday)...

This is the biggest 2-day drop and the heaviest volume in the history of the stock...

The scandal that is reverberating through the global supply chain...

And casting a new shadow over the country’s reputation for precision manufacturing, and as The New York Times reports, the fallout has the potential to spread to hundreds of companies.

Manufacturers of cars, aircraft and bullet trains have long relied on Kobe Steel to provide raw materials for their products, making the steel maker a crucial, if largely invisible, pillar of the Japanese economy.

The scandal hits a tender spot for Japan.

The country relies on its reputation for quality manufacturing as a selling point over China and other countries that offer cheaper alternatives. But its reputation has been marred by a series of problems at some of Japan’s biggest manufacturers.

Last week, Nissan Motor said unqualified staff members had carried out inspections at its factories, prompting the carmaker to recall 1.2 million vehicles, though it was not clear if the quality of the vehicles had been affected. Mitsubishi Motors and Suzuki Motor both admitted last year that they had been exaggerating the fuel economy of their vehicles by cheating on tests.

Perhaps the biggest blow to Japan’s reputation for quality has come from Takata, the airbag maker that was at the center of the largest auto safety recall in history, involving tens of millions of vehicles. Its faulty airbags have been blamed for more than a dozen deaths. Takata declared bankruptcy in June.

The extent of the problems at Kobe Steel are still unfolding: "The falsification problem has become an issue that could destroy international faith in Japanese manufacturing,” the Japanese financial newspaper Nikkei said in an article on Tuesday.

Japan's "Deflationary Mindset" Grows As Household Cash Hordes Reach Record High

After being force-fed more stimulus than John Belushi, and endless rounds of buying any and every asset that dares to expose any cracks in the potemkin village of fiat folly, Japan remains stuck firmly in what Abe feared so many years ago - a "deflationary mindset."

As Bloomberg reports, cash and deposits held by Japanese households rose for 42nd straight quarter at the end of June as the nation’s consumers continued to favor saving over spending.

The "deflationary mindset" that the Bank of Japan is battling to overcome was also evident in the money laying idle in corporate coffers, which stayed near an all-time high, according to quarterly flow of funds data released by the BOJ on Wednesday.

Still, as Bloomberg optimistically notes, with the economy expanding much faster than its potential growth rate, greater inflationary pressures could be on the way, which may prompt a shift in behavior by consumers and companies... or not!

China Is Building An Army Of Robot Workers

As wages for Chinese workers’ skyrocket, the country’s manufacturers are scrambling to replace humans with machines, in many cases to preserve thin profit margins that have been choked by debt service.

But according to a report from Bloomberg Intelligence, China’s embrace of automation – its companies are installing machines faster than in any other country – could have unintended consequences for the global economy, as the robots force wages to sink, inequality to balloon, and consumption to collapse.

To be sure, the blistering pace of AI adoption hasn’t dented Chinese wages – at least not yet.  

“Pay gains are intact. Domestic manufacturing workers with a high-school education saw wages rise 53 percent from 2010 to 2014, according to China Household Finance Survey data cited by BI.”

But as one economist explained, the increasing reliance on automation could thwart the Communist Party’s plan to transition to a service-focused economy.   

“By turbocharging supply and depressing demand, automation risks exacerbating China’s reliance on export-driven growth – threatening hopes for a more balanced domestic and global economy,” BI economists Tom Orlik and Fielding Chen wrote.”

However, China’s leaders have embraced a different view. Beijing believes that if it can automate sectors like car manufacturing, electronics, appliances. Logistics and food, its citizens will focus on better service-sector jobs, while also compensating for an anticipated shrinking of the workforce. The Communist Party’s Made In China 2025 plan and a separate five-year plan governing the expansion of its robot workforce were launched last year.

“Robots are at the core of the government’s sweeping Made in China 2025 plan to upgrade factories to be highly automated and technologically-advanced. Replacing assembly-line workers will also help it to offset a shrinking working-age population.”

As part of its plan, China is also hoping to produce more of its own robots, crowding out the foreign firms that presently dominate that market.

“The government also wants to increase the share of Chinese-branded robots in the country’s $11 billion market to more than 50 percent of total sales volume by 2020 from 31 percent last year, and aims to produce 100,000 robots a year by 2020, compared with 33,000 in 2015. That means competition will intensify for foreign firms that supply 67 percent of China’s robots, such as Japan’s Fanuc Corp. and Yaskawa Electric Corp., according to BI.”

While China is quickly catching up to South Korea and other global robotics leaders, the overall population density of robots in China remains below the world average.

In a viral video published back in April, the People’s Daily provided a glimpse into the rapidly approaching future of China"s labor force: The video, also released by the SCMP, shows hundreds of round Hikvision robots, each roughly the size of a seat cushion, swiveling across the floor of the large warehouse in Hangzhou. A worker is seen feeding each robot with a package before the machines carry the parcels away to different areas around the sorting center.

The robots sort more than 200,000 packages a day.

And as engineers continue to make progress building robots that are better suited toward working alongside humans, the robots’ numbers will probably continue to skyrocket.

While the impact on wages has been mild for now, it likely won’t stay that way forever.
 

Japan GDP Surges 4%, Most In Two Years, On Jump In Government Stimulus Spending

Japan"s economy grew by 1% sequentially, and 4% on an annualized basis in Q2, smashing expectations of a 2.5% print and well above the upward revised 1.5% in the first quarter; it was also the the highest quarterly growth since a 5% print in Q2 2015, Japan"s Cabinet Office reported, and the 6th consecutive quarter of expansion for recently embattled Prime Minister Shinzo Abe, who has plunged in the polls following a series of corruption scandals.

The unexpectedly strong GDP print was driven by a 9.9% jump in private non-residential investment as well as an striking 21.9% annualized surge in public investment as some of the public works spending included in last year’s economic stimulus package starting to emerge; meanwhile exports declined.

On a sequential basis, GDP rose 1.0%, above the 0.6% expected, up from the 0.4% in Q1 and the highest print in just over two years.

Annualized private demand soared by 5.3%, or 1.3% higher compared to the first quarter, an impressive jump from the previous quarter’s rise of 0.2%. Private consumption rose 0.9% in Q2, more than double the 0.4% reported for the first quarter.  Aside from the clearly "one-time" surge in public investment, which in the second quarter exploded by an annualized 21.9% as some of the public works spending included in last year’s economic stimulus package have started to emerge, private non-residential investment climbed 2.4% from 0.9% in Q1, while government consumption grew 0.3%, bouncing from a 0.1% contraction in the prior quarter.

Finally, spoiling the otherwise pristine report was the unexpected drop in exports of goods and services which dropped 0.5% on a quarterly basis and -1.9% annualized, the lowest export number since Q2 of 2016. The plunge in net exports dragged Japan"s headline growth figure down 0.3% points.

Ahead of the number, Goldman"s Japan analyst Naohiko Baba said that "we estimate Apr-Jun real GDP growth of +2.4% qoq annualized, up from +1.0% in Jan-Mar. While we expect net exports to turn to a negative contributor, we think private-sector demand was strong for personal consumption and capex. We also expect double-digit growth for public capital formation, with some of the public works spending included in last year’s economic stimulus package starting to emerge. We think Apr-Jun GDP will show a clearer tilt toward domestic demand led growth. "

Separately, Barclays analysts said that "looking forward, we expect real GDP to rise an annualized 1.3% in Q3, 0.9% in Q4, and 1.0% in Q1 2018 on a q/q basis,” they wrote. “For Q3, we believe external demand will reverse to a positive contribution and anticipate a continued economic boost from last fiscal year’s second supplementary budget of 11 October 2016?.

Considering the absolute non-reaction in markets, where the USDJPY is up barely 20 pips in a delayed response to Japan"s "best" economic report in over two years, either nobody puts any credibility in this number, or just as likely, fundamental economic data no longer matters to any investing decisions.

Finally, as some commentators put it best on Twitter, "yen climbs on nuclear war. yen falls on strong GDP. good"

yen climbs on nuclear war. yen falls on strong GDP. good

— Lee Saks (@Lee_Saks) August 14, 2017

What Everyone Will Ask Kuroda Today: Why Has The BOJ Has Already Tapered QE By 45%?

Unlike Wednesday"s FOMC decision, few are excited about tonight"s BOJ announcement in which Kuroda is expected to announce no changes; in fact the biggest mystery is what time the "fluid" meeting will take place. What little suspense there is in Kuroda"s remarks, will likely be confined to his comments during the press conference about the BOJ"s exit strategy.

For those who plan to stay up in hope of catching some of the USDJPY volatility upon the BOJ announcement, here is a recap of what to expect from BofA:

We expect the Bank of Japan to remain on hold at its 16 June monetary policy meeting (MPM), keeping both its targets for rates and risk asset purchases unchanged. We also think the policy board will retain the "about ¥80tn" guideline for JGB purchases and refrain from announcing official tapering out of concern that doing so may send an unintentionally hawkish message to the markets. The central bank has every reason to be cautious. Growth has been running well above potential in 1H17, but price pressures remain weak, with BoJ-style core inflation (CPI ex fresh food and energy) languishing at 0.0% as of April. Downside risks to the inflation outlook suggest the BoJ is nowhere close to hiking rates or shrinking its balance sheet.

However, with the media and some members of parliament expressing increased interest in the BoJ"s "exit strategy", we believe it will be a focal topic at Governor Kuroda"s post-MPM press conference. But we doubt he will say anything new. The governor will likely remain cautious in his communications, reiterating that the central bank is not yet considering specific plans, given the 2% inflation target remains a long way away.

The Sankei Shimbun recently reported that the BoJ board will consider upgrading its overall assessment of the economy at the 20 July MPM, when it updates its estimate of the output gap in the next quarterly Outlook Report. However, risks to the board"s FY17 Japan-style core inflation forecast of 1.4%YoY are tilted firmly to the downside, in our view, especially if commodity prices stay at current levels. Another downgrade to the board"s CPI forecasts seems likely in July, or by the October MPM at the latest. In our view, the last thing the BoJ wants to do in this situation is to signal policy tightening.

In the absence of policy changes, the focus will be on Governor Kuroda"s post-MPM press conference, scheduled for 3:30pm JST. We expect the Q&A to be dominated by two themes: (1) the BoJ"s latest stance on an exit strategy from ultra-accommodative monetary policy and (2) the seeming contradiction between the policy board"s commitment to increase its JGB holdings at an annual rate of "about ¥80tn" and the ongoing slowdown in the central bank"s bond purchases, which we now estimate is running at about ¥60tn.

But before we get into BofA"s discussion of these two topics, it is worth reminding readers of something we first noted three months ago: the BOJ is quietly engaging in stealth tapering of its QE, for the same reason that the ECB will have no choice but to taper its own purchases - it is running out of eligible bonds to buy.

In a report by JPM, the bank calculates that in May, the Bank of Japan bought just Yen7.89 trillion ($71.6 billion) worth of Japanese government bonds. This was the the least outright buying since October 2014, when the central bank surprised markets by saying it would increase its asset purchases. Since launching its own version of QQE (before it twisted into Yield Control), the central bank has kept in place its target of increasing bond holdings each year by "about" Yen80 trillion. However, at the current rate of buying, the WSJ writes, the holdings are set to rise this year by only about Yen55 trillion.

The central bank is "technically tapering," said Hiroshi Shiraishi, senior economist at BNP Paribas in Tokyo. This can be clearly seen in the following chart from Bank of America.

Aside from the a declining supply of bonds held by the private sector, one tactical reason why the BOJ may be buying fewer bonds is its "yield curve control" policy, which aims to keep the yield on 10-year government bonds at zero. This implies it can buy fewer bonds when the yield is close to that target. Wednesday, the yield was at 0.06%.

Previously, Kuroda has acknowledged this slowdown, but has been quick to declare that what effectively amounts to a 35% taper doesn"t signal a retreat from easy-money policies. "At this stage, we are not exiting," Kuroda said at The Wall Street Journal"s CEO Council meeting in Tokyo on May 16.

Yes but what happens when the BOJ officially announces the need to start tapering? And more importantly, what will be the reaction of the market, which has so far taken the "technical tapering" in stride, in the country where the central bank already owns over 43% of all Japanese government bonds, and where the BOJ"s balance sheet is 90% of GDP?

So, here is Bank of America again explaining what Kuroda will likely respond if and when asked about (1) the BoJ"s latest stance on an exit strategy from ultra-accommodative monetary policy and (2) the seeming contradiction between the policy board"s commitment to increase its JGB holdings at an annual rate of "about ¥80tn" and the ongoing slowdown in the central bank"s bond purchases, which we now estimate is running at about ¥60tn.

We think Governor Kuroda"s communications will remain cautious in response to both issues. Attention on the BoJ"s exit strategy has increased since Bloomberg reported in an 8 June article that the BoJ was considering "re-calibrating its communications to acknowledge that it is thinking about how to handle a future exit from monetary stimulus, without giving the impression that this is on the agenda anytime soon." At the same time, opposition lawmakers have raised greater concerns over the BoJ"s financial health when the central bank eventually raises interest rates and have pressed the central bank to disclose detailed exit plans and its associated costs. While the Bloomberg article did not contain any new information, in our opinion, it ended up causing some volatility in the markets, suggesting investors will remain sensitive to Governor Kuroda"s comments. For this reason, we think the governor will likely say very little on the subject.

On slowing JGB purchases, Governor Kuroda is likely to acknowledge-as he has in recent Diet hearings-that the rate of increase in the central bank"s JGB holdings has recently fallen to around ¥60tn on an annualized basis. However, we expect the governor to stress that the slowdown in JGB purchases does not reflect intentional "tapering" but reflects an automatic adjustment mechanism under yield curve control (YCC). In other words, the slowdown in BoJ bond buying is a result of reduced upward pressure on JGB yields, reflecting a fall in US rates.

In other words, Kuroda will hope that the BOJ"s communication remains on autopilot. Still, at a time when the Fed just laid out what its balance sheet normalization would look like, and when even the ECB has "trial ballooned" it will soon follow, the discussion will inevitably turn to the most sensitive topic facing not only the BOJ, but Japan itself: how does the central bank hope to reduce its gargantuan balance sheet, which recently surpassed that of the Fed. Here is BofA"s answer:

The BoJ has continued purchasing significant amounts of JGBs for over four years under its QQE policy, and consequently its balance sheet has ballooned to over ¥500tn, comparable in size to Japan"s GDP. Various side effects have emerged. Since the beginning of 2016, the BoJ has carried out more JGB lending through Securities Lending Facility operations, a sign that the market shortage of JGBs has become more serious. Moreover, the repo rate plunged near the end of FY16 (March 2017) due to strong demand for TBs. Recently, the BoJ has reduced its purchases of short- and medium-term JGBs, so its Securities Lending Facility operations have also dwindled. The rise of short- and medium-term yields shows supply-demand has eased somewhat. However, if investor demand (and not necessarily such strong demand) turns to JGBs again, the risk is rising that supply-demand will tighten and prices will be distorted.

Naturally the BoJ knows this very well, so last year it introduced yield curve control (YCC) as a step on the way to making monetary policy more sustainable. So far the BoJ has succeeded at maintaining yields near targeted levels, and it has quite smoothly reduced its JGB purchases. The year-on-year increase in the BoJ"s holdings of JGBs has declined to about ¥70tn, well below the guideline figure of ¥80tn. If the current purchasing pace is maintained, YoY growth in holdings will decline even more. The BoJ"s gross annual purchases amount to about ¥96tn now, and at the end of May it held ¥43tn of JGBs that were set to be redeemed within one year, so its net purchasing pace is around ¥53tn now. For five months from January to May 2017, the BoJ increased its JGB holdings by ¥30tn, and if the current purchasing pace is maintained, its JGB holdings should increase by about ¥60tn in 2017.

Whatever explanation Kuroda comes up with, the reality is that the "liquidity impulse" generated from purchasing ¥53tn vs the designated ¥80tn, represents a greater than 30% reduction. And sooner or later, the market will realize that the liquidity added to the market by the BOJ is nearly half of what it should be in theory. That moment could result in a rude awakening, as it will likely come as the Fed continues to tighten its own monetary policy with the ECB potentially starting to tighten too as it is about to run out of eligible Bunds to buy. So how will the BOJ proceed? Here, again, is BofA:

We think the BoJ will find it difficult to change policy for the time being, so the JGB market"s volatility might stay low for a while. However, as the economic recovery deepens and domestic inflation picks up, it would not be surprising to us if the BoJ increased its communications with the market and put more effort into forming a consensus about its exit from QQE. Of course, it will proceed cautiously to avoid sudden yield surges and yen appreciation. If some conditions are fulfilled-inflation rises to about 1% and the Fed and ECB proceed steadily towards monetary normalization-it is possible the BoJ shifts from excessive easing to a more sustainable monetary policy even if its exit lies well in the future (The BoJ"s public and private face). One risk is that an unexpected event triggers global risk avoidance leading to lower yields and a simultaneous round of yen appreciation. For example, even if the 10yr yield fell far below its target, a reduction in JGB purchases could prompt further strengthening of the yen. Steering this course would not be easy. In that case, the BoJ would probably need to take countermeasures such as setting a minimum yield and continuing with its purchase operations.

Finally, here is Bank of America"s take on what the BOJ"s action could mean for the Yen:

The BoJ is widely expected to leave its policy unchanged, and the Fed"s stance and US data will be the predominant concern for the USD/JPY. We believe the BoJ is careful about not sending the wrong signal about a policy exit when the financial market is questioning the strength of the US and Chinese economies, and Japanese inflation measures are hovering around 0%. Instead, the market is likely to focus on upcoming US data to judge if the Fed is right about its policy normalization plan, forcing the market to catch up, or the Fed has to adjust toward the dovish market expectation.

We argued that self-sustained USD strength may need more time to materialize such that Japanese equities may be a better position for now. In fact, our US strategists argue it could take a few more months to know whether the US will reform its tax system. We prefer being long NZD/JPY for now while we fundamentally remain constructive on USD/JPY.

In short, for now the BOJ remains on autopilot, which is why don"t expect much from today"s BOJ announcement.

Japan GDP Rises 2.2%; Longest Growth Stretch In 11 Years

In the same quarter in which the US teetered on the verge of contraction (supposedly due to inclement weather despite not one but two seasonal adjustments meant to eliminate "residual seasonality"), Japan grew at the fastest pace in a year and nearly triple that of the US.

On Thursday morning, Japan"s Cabinet Office reported that Japan"s Q1 GDP rose at a 2.2% annualized pace, beating estimates of 1.7% growth, and up from the 1.2% SAAR growth in Q4 of 2016. It was also Japan"s 5th consecutive quarter of positive GDP, the longest stretch of growth going back 11 years. 

On a sequential basis, Japan"s economy grew by 0.5% in Q1, up from 0.3% in Q4, and in line with expectations (which begs a question, how did economists who predicted 0.5% sequential growth get 1.7% annualized, while the actual number was indeed 0.5%, yet when annualized resulted in 2.2%. The answer is probably in non-GAAP rounding).

Broken down by components, domestic demand rose 0.4% in Q4 compared to the previous quarter, when consumption posted a modest decline. Residential investment was the biggest growth component of private demand, rising by 0.7%, while public demand was a more modest 0.1%. Private inventories added 0.1%, while net exports rose 2.1% in the quarter, down modestly from 3.4%, due to the 5% increase in the Yen over the time period. Imports were a 0.2% offset to annualized GDP growth, after growing by 1.4% sequentially.

The number easily beat Goldman"s expectations. This is what the bank said ahead of the report: "We forecast +1.7% qoq annualized real GDP growth in Q1, accelerating from +1.2% in 2016Q4. Steady export growth, recovering consumer spending and inventory accumulation are the main contributors to Q1 growth, while we expect small correction to private capex, which advanced +8.4% qoq annualized in the prior quarter. Positive GDP growth in Q1 would mark a fifth quarter of sequential growth, for the first time in 11 years, confirming the solid state of Japanese economy."

Some other economist reactions via Bloomberg:

• "Exports have taken the lead in the recovery, and domestic demand wasn’t bad, showing resilience with household spending turning positive," said Masaki Kuwahara, senior economist at Nomura Securities Co., which correctly forecast the 2.2 percent expansion.


• "Looking ahead, the growth rate will slow a bit, if not turn negative, toward the second half of this year as China’s economic indicators are weakening a bit. I’m expecting exports to slow down, weighing on the overall growth rate,” said Kuwahara.


• "It’s a pretty impressive number but I don’t think this can continue for a while," said Takashi Shiono, an economist at Credit Suisse Group AG.


• "Uncertainties are increasing rapidly with the chaos at the White House and a pickup cycle in global production could end soon," said Shiono. "The risk-off sentiment in the market will put pressure on the yen to strengthen and that will weigh on Japan’s economy."

The strong GDP growth may come as disappointment for Japan bulls, however. Already the BOJ has quietly tapered its bond purchases from JPY80 trillion/year to JPY60 trillion, and Kuroda, with less than a year left on his tenure, will be looking for excuses to not only officially taper purchases - here he has no choice as the BOJ has about 1 year left of eligible bonds to monetize - but to potentially give the old rate hike experiment another try, even if the BOJ"s latest minute reluctantly admitted that despite labor shortages the economy has failed to generate the much needed inflation. Today"s strong GDP print just gave Kuroda the excuse he needs to hint at even more monetary tightening, assuming of course the the threat of US presidential impeachment has been postponed indefinitely.