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June 12, 2021

Bank of Japan Governor Haruhiko Kuroda may have just pulled off history’s biggest tease.

Since 2013, Kuroda has overseen an unprecedented expansion of a central bank’s balance sheet. By late 2018, it topped the size of Japan’s $5 trillion economy—and has only grown since. Though most of those purchases were bonds, the BOJ also hoarded stocks via exchange-traded funds with increasing fervor.

 In 2020 alone, Kuroda’s team added $65 billion to its ETF holdings, making the BOJ Japan’s investment “whale.” That’s up from $38 billion in 2013.

Yet in May—and here comes the big tease—the BOJ went an entire month without adding to its EFT holdings, the first 30-day pause in eight years. That has many investors believing Kuroda is suddenly serious about pulling BOJ support for stocks.

Don’t bet on it, as Japan’s Covid-19 recovery lags the rest of the developed world, and perhaps significantly.

The yen’s 6% drop versus the U.S. dollar tells the story as well any data set. As North America and Europe stabilize and begin producing decent growth, the forces behind Japan’s downturn remain stubbornly negative. Retail sales, industrial production, wages and business confidence have many economists convinced Japan might not return to pre-Covid levels until 2023.


China is doing so now, while laggards are generally looking at 2022 rebounds. That Japan’s revival is still two years out is influencing inflation expectations. As the U.S. and other top economies brace for rising consumer prices, Japan’s are heading back toward the red.

In April, core consumer prices fell for the ninth straight month. The 0.1% year-on-year decline was remarkably out of step with trends virtually everywhere else. It helps explain why the yen is the worst-performer among Group-of-10 currencies. It explains, too, why the BOJ won’t be “tapering” anytime soon, even if the Federal Reserve does in Washington.


It follows, then, that the BOJ’s ETF holdings are here to stay—and in ways that offer lessons for peers.

By the time Kuroda arrived at BOJ headquarters, the central bank had already been toying with quantitative easing for 12 years. Fourteen, if we’re talking about when the BOJ became the first major monetary authority to slash interest rates to zero. Kuroda supersized the effort. First, he cornered the government bond market. Then, the stock market.

 Yet all this support from a state-run institution is warping stock market dynamics. In February, the BOJ’s paper gains on ETF holdings hit a record $149 billion the same week the benchmark Nikkei 225 Stock Average rose to a three-decade high. That gain is more than double Myanmar’s annual gross domestic product.

The problem, of course, is that the BOJ is effectively trapped. If it tries to withdraw from the bond market, yields would almost certainly shoot higher. The only thing making Tokyo’s 250% debt-to-GDP ratio seem somewhat manageable is 10-year rates at 0.06%. Because credit is essentially free, Japan supports its growth via deficit spending. 

It’s not a reach to say Tokyo had created a monetary Frankenstein, of sorts. If the BOJ isn’t careful, this monster will get out of control and come back to harm its creator.

Fed Governor Jerome Powell is in a similar predicament. He is sure to learn soon that pushing into myriad asset classes is one thing. Exiting is quite another. If Powell tries to taper, politicians, corporate CEOs, bankers and investors alike would howl in protest.

The powerful selloff sure to ensue, meantime, could undo post-Covid recoveries everywhere. Any hint the Fed might be winding up liquidity would probably accelerate the yen’s downtrend.

Hedge fund bets against the yen are near the highest levels since early 2019. Part of the negativity reflects cash flowing out of Japan for mergers and acquisitions. Direct investment overseas, including M&A, jumped nearly 30% between January and March from a year ago.

Most of it, though, reflects fears that Japan’s recovery is two years out. Even good news on Japan these days tends to be bad. Case in point: the economy, it turns out, only shrank 3.9% in the first quarter, better than the initial estimate of a 5.1% contraction.

“We expect the economy will experience another contraction in Q2 given the extended restrictions, which will weigh heavily especially on the services sector,” says Makoto Tsuchiya at Oxford Economics.

Deflation, meantime, is once again a much bigger risk than rising prices. All the more reason to think the BOJ’s $5 trillion balance is more likely to grow than shrink as Japan staggers through 2021. And the monsters it created along the way loom on the horizon.

Source: Forbes
Image Source: Getty Images