- As Haruhiko Kuroda steps down as governor of the Bank of Japan (BOJ) after a decade, the soon-to-be-appointed new governor, Kazuo Ueda, is expected to review the BOJ’s ultra-easy monetary policy in a new light.
- We outline three scenarios around the BOJ’s monetary policy and assess their potential impact on investment portfolios.
- In the case of “gradual policy normalization,” our model portfolio could gain 0.3%. Under the “full-scale tightening” and “dovish policy” scenarios, the same portfolio may experience a 6% or 3% loss, respectively.
As Haruhiko Kuroda steps down after a decade as governor of the Bank of Japan (BOJ), the central bank gets a new governor on April 9. The soon-to-be-appointed Kazuo Ueda, an economics professor and former member of the BOJ policy board, is expected to review the BOJ’s ultra-easy monetary policy. This “outsider” to Kuroda’s reign has the potential to shake things up, but what could that mean for Japanese institutional investors? Under our baseline “gradual policy normalization” scenario, a portfolio of global equities and U.S. and Japanese government bonds could gain 0.3%. In our less favorable scenarios, “full-scale tightening” and “dovish policy,” however, the same portfolio may experience a 6% or 3% loss, respectively.
Japanese monetary policy and potential scenarios
While monetary policy1 is not the only factor affecting a country’s inflation, Japan’s inflation rate had been mostly in positive territory since Kuroda took office in 2013 — until the pandemic brought it to negative in 2020. Inflation accelerated in 2022 due to the rise in import prices, but the BOJ’s latest outlook estimated that inflation will slow to below 2% in 2023, as factors that pushed up import prices, such as high energy prices and a weaker Japanese yen, are expected to wane.
Japanese inflation spiked in 2022
Source: Portal Site of Official Statistics of Japan (e-Stat), MSCI
While the data suggests the period of persistent deflation seems to have passed, the side effects of the monetary policy have been the subject of a lingering debate, from liquidity issues in ETF markets to distortion of the price-discovery function of bond markets. The BOJ recognized that the functioning of bond markets had “deteriorated” and relaxed its policy of yield-curve control in December.2
Ueda has said that the current ultra-easy monetary policy needs to be reviewed at some point, but also stressed that easy monetary policy “is appropriate” and “must carry on,” considering the state of the economy.3 With this background, we outline three scenarios for the Japanese economy and the BOJ’s monetary policy, with the baseline scenario reflecting Ueda’s balanced view and assuming he pursues gradual policy normalization while keeping monetary policy accommodative:4
- Gradual policy normalization: U.S. rates remain high, while the economy grows slowly. No further global downside risks materialize. The BOJ seeks policy normalization, but at a very gradual pace to keep monetary policy accommodative. Both U.S. and Japanese stock prices rise on the economic recovery. JPY appreciates vs. USD as the Federal Reserve eventually pauses its rate hikes, while the BOJ seeks normalization.
- Full-scale tightening: Central banks fail to tame inflation and need to hike rates further. Global inflation infiltrates Japan through import prices, and persistent inflationary pressure raises Japanese consumers’ inflation expectations. Considering accelerating Japanese inflation, the BOJ is forced to implement full-scale tightening. Both stock and bond prices fall. JPY depreciates vs. USD.
- Dovish policy: As a result of the fight against inflation, the U.S. economy goes into recession, and the Federal Reserve cuts rates. The BOJ stops pursuing policy normalization, faced by the worsening economic environment and expands its asset-purchasing program. Both U.S. and Japanese stock prices fall due to the recession. JPY appreciates vs. USD as U.S. nominal rates fall more than Japanese nominal rates.
Our scenario assumptions
Scenario assumptions are informed by the MSCI Macro-Finance Model, analysis of historical data and judgment. These are not forecasts, but hypothetical narratives of how the macroeconomic scenarios could affect multi-asset-class portfolios. Breakeven inflation (BEI) is measured in basis points (bps).
Potential implications for Japanese investors’ portfolios
To assess the scenarios’ impacts on multi-asset-class portfolios from Japanese investors’ point of view, we used MSCI’s predictive stress-testing framework and applied it to a hypothetical composite portfolio consisting of global equities (Japan and global equities ex-Japan) and U.S. and Japanese government bonds. The chart below shows details of the impact by asset class in JPY terms.
Impact across asset classes under our scenarios in JPY
Portfolio impact of the scenarios based on market data as of Jan. 31, 2023. Note that the stress test results capture the effect of repricing of the assets, not the income component. Japanese equity is represented by the MSCI Japan Index, global equity by the MSCI ACWI ex Japan Index, U.S. Treasurys by the MSCI USD Government Bond Index and Japanese government bonds by a market-cap-weighted custom Japanese-government-bond portfolio. The composite portfolio is an equal-weighted mix of Japanese equities, global equities, U.S. Treasurys and Japanese government bonds.
While the BOJ’s future policy direction is an important factor for Japanese stocks and bonds, the return of a composite portfolio, which is diversified across Japanese and non-Japanese assets, was impacted by external factors as well. Under our “gradual policy normalization” and “dovish policy” scenarios, Treasury prices rose in USD terms; but in JPY terms, the gain was offset by the depreciation of the USD against the JPY. On the other hand, the depreciation of the JPY under the “full-scale tightening” scenario partly offset the losses from the global-stock and -bond bear markets.5
Our result suggests the asset-class returns could vary significantly depending on the scenario. Faced with this uncertainty, investors may wish to evaluate a range of potential scenarios and consider appropriate strategies.
1To achieve the 2% inflation target, the BOJ is currently implementing “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control (YCC).” Under this policy, the BOJ is controlling the policy rate and 10-year government-bond yield. They are also purchasing equity and REIT ETFs.
2“Statement on Monetary Policy.” Bank of Japan, Dec. 20, 2022.
3“Factbox: Kazuo Ueda: Who is the new Bank of Japan governor and what can we expect from him?” Reuters, Feb. 10, 2023.
4For the global economy, we incorporate scenarios from our recent blog post to determine external factors that may affect the BOJ’s decision. The “gradual policy normalization,” “full-scale tightening” and “dovish policy” correspond to the “baseline,” “mild stagflation” and “hard landing” scenarios, respectively.
5The results are generated by using model correlations to propagate shocks to the portfolios, using MSCI's BarraOne®. MSCI clients can access BarraOne® and RiskMetrics® RiskManager® files for these scenarios on the client-support site.