In his first meeting at the helm of the Bank of Japan (BoJ), Governor Kuroda cast aside former Governor Shirakawa’s caution and announced that the BoJ will adopt a more aggressive monetary policy stance in order to meet its 2% inflation target within two years. The rate of inflation is currently running at -0.7%. The BoJ said they will increase their government bond purchases from JPY 3.8 trillion per month to JPY 7 trillion per month and, significantly, will also target longer maturity Japanese Government Bonds (JGB) and include up to 40-year government bonds in their purchase program. The BoJ will explicitly target a doubling of the monetary base by the end of 2014, and will achieve this by almost doubling the size of its own balance sheet.
Wow! However the Bank of Japan will by no means be the last major central bank to act. Governor-elect Carney has already been promised a broader remit than that given to outgoing Bank of England Governor Mervyn King, and the Monetary Policy Committee (MPC) will be able to look past current above-target inflation and provide more monetary easing if required. Risks of a triple dip recession in the UK have not gone away and we expect a major policy initiative in the early days of Governor Carney’s tenure.
Meanwhile peripheral Europe continues to muddle along. No news from Italy is taken as good news as the market appears to accept that there will have to be a second general election later this year in order to try to resolve the political deadlock. Due to a number of technicalities, a second general election cannot be held until late summer and in the meanwhile, abundant market liquidity and the threat of ECB action will continue to keep a lid on yields. Cyprus meanwhile received two pieces of positive news: the IMF will contribute €1 bn towards the sovereign’s bailout, and the eurozone’s loan to Cyprus will be made at a highly subsidized rate of 2.8%, with repayments not scheduled to begin until year 10. Highly advantageous debt restructuring deals have already been given to Greece and Ireland, and Cyprus is the latest peripheral country to benefit from effective fiscal transfers from the core countries in the eurozone.
The ample supply of liquidity and relief that the US did not fall off the full fiscal cliff after all (Q1 GDP is tracking at above 3%, annualized), coupled with well-anchored inflation expectations all suggest that the return from bonds will again surprise to the upside in 2013. This rising tide of central bank liquidity will lift all bond boats including much maligned government bonds. JGB yields hit an all time low after the announcement! We still favor high yield, emerging markets and, selectively, high grade corporate bonds. Indeed even with some corrective spread widening during Q1, European high yield provided positive returns during the quarter, reflecting the power of carry in this low interest rate environment.