Something bigger than just yield curve control (YCC) timing is going on in Japan. Something is changing, something potentially significant.
Two significant things shifted before the July Bank of Japan meeting (MPM). First, the LDP won big in the Upper House elections, giving Prime Minister Kishida a mandate for the next three years to fully pursue his reflationary agenda. Second, the BoJ Tankan quarterly business survey showed that inflation expectations are continuing to build and that 1y inflation expectations are now well above 2% and closer to 3%.
So, the message in July was that inflationary pressures in Japan are clearly building – and not just in relative terms, but to levels north of the BoJ’s 2% target. And to amplify these pressures, Kishida was given a three-year mandate to fully pursue his reflationary agenda. Since then, the data in Japan has continued to suggest that NGDP is high and rising. However, as we know, the BoJ has continued to brush that off and has kept its foot on the easing pedal.
In mid-November, BoJ Governor Kuroda spoke to business leaders in Nagoya. The BoJ and Kuroda have been operating monetary policy with the ‘aim to provide a favorable environment for firms to raise wages and to achieve the price stability target in a sustainable and stable manner, accompanied by wage increases.’
Kuroda has said the reaction function is simple. Get the NGDP virtuous cycle going, and have it sustained via wages. Then we can talk about monetary policy tightening, but not until then. So, with that said, there are few standouts from the Nagoya speech.
Kuroda has said 2% inflation accompanied by wage gains, a self-reinforcing virtuous NGDP cycle, is job done. And the wage commentary is starting to sound optimistic.
- ‘In addition, although Japanese firms had long been cautious about raising prices, those for a wide range of products have been raised recently. Close attention to firms’ price-setting behavior going forward is warranted.’
- ‘The Bank will closely examine the outlook for economic activity and prices, as well as the upside and downside risks to the outlook.’
- ‘Therefore, wages of non-regular employees, which account for a large share of those working in the services industry, are expected to rise. This could gradually spill over to wages of regular employees, such as at small and medium-sized firms.’
If you have been following Kuroda speeches this year, this is a bit of a tone change. Is it going to lead to anything before he hands over the keys to Amamiya or Nakaso next year? Maybe not, but it is the beginning of an acknowledgment that policy is ‘working’, and that matters.
To me, the NGDP backdrop has changed in Japan. NGDP is over 5% and possibly reinforced by a Capex cycle along with a massively weak currency. Corporate profits are at decade highs, Tankan surveys show inflation expectations at 40y highs, and the LDP is pursuing substantial fiscal policy accommodation into a positive output gap.
However, the BoJ is not pursuing gradual policy; they are pursuing a much more radical form of what the Fed tried with FAIT. The point of FAIT is you only change your policy stance (max easing) when you achieve your outcomes in a realized way, not when you are on the way to achieving those goals (i.e. path).
The BoJ is not going to gradually adjust their approach. There is not going to be a June 2021 FOMC for the BoJ where the 2023 dot goes up. They are going to stay max easy until they are ready to change, and then they will change. And to me, the reason a lot of people have had false starts trading the BoJ this year is that this is a 0% or 100% policy approach. And until they are 100% there, it is pedal to the metal.
To me, the question in Japan now is much less ‘does it work’ and more ‘when will the BoJ acknowledge it?’
Inflation is at 3%, surveys have inflation expectations at their highest levels in 40 years. Capex intentions are at their highest since China’s ascension to WTO in the early 2000s. The yen on a real effective exchange rate basis is at its lowest level in history. And wage growth is starting to pick up too.
Many BoJ officials have said the only way to really increase and sustain higher levels of NGDP is if wage-setting behavior in Japan changes. Well, NGDP is running at 5%, Capex intentions are high, and the unemployment rate is 2.5%. It seems like wage growth in Japan has momentum especially in this FX backdrop. What if Japan’s radical policy experiment ends next year and rate hikes begin?