Market Mover - BNP PARIBAS - Investment Services India

This section is classified as non-objective researchJGBs: No Impact from the BoJ’s Decision• The BoJ increased the size of the AssetPurchase Program by JPY 5trn, aiming at JGBpurchases.• STRATEGY: Take profit in the JGB 2y/5y/10ybutterfly.No impactThe BoJ has increased the size of the Asset PurchaseProgram by JPY 5trn to JPY 55trn, directed at JGBpurchases. However, the decision disappointed somemarket participants, who had strongly expected anextension of maturities of JGBs subject to purchases.The USDJPY exchange rate dropped to a new post-WWII low of 75.73 on 26 October, which resulted in theadditional easing measures by the BoJ. However,aggressive action was difficult this time, with the policyrate already at just 0–10bp, and a further increase inoutright JGB purchases impossible without violatingthe BoJ's self-imposed ‘banknote rule’ – which statesthat the central bank's long-term JGB holdings shouldnot exceed the total value of banknotes in circulation –in the relatively near term. As the JGB buyingoperation via the Asset Purchase Program is notincluded in the banknote rule, the BoJ’s decision toincrease its size was widely expected by the market. Inthe future, the BoJ may consider the extension ofmaturities of JGBs to 3-5 years from 2 years, or couldcut its Complementary Deposit Facility (excessreserves) rate. However, while these measures mayhave some success in lowering short-end interest rates,we see little prospect of them reversing the yen's rise.The BoJ’s latest Outlook for Economic Activity andPrices still expects a gradual economic expansiondespite a lowering of growth forecasts. CPI inflationforecasts have also been lowered to around zero toreflect the impact of August's index rebasing, leavingmarket participants with a strong expectation thatmonetary policy will remain highly accommodative.Range boundThe 10y yield continues to hover around 1% as theJGB market remains extremely insensitive toexogenous factors such as the European sovereigndebt crisis and fluctuations in US Treasury yields.However, we expect JGB market participants to moveout of wait-and-see mode now that the second half ofFY 2011 is well under way. If US Treasury yields risefurther, we may see JGB yields follow the trend. In themeantime, we recommend taking profit in the JGB2y/5y/10y butterfly (long 5y) which has a bullish bias,Chart 1: Asset Purchase Program (JPY trn)Program sizebeforethe increaseAmount ofincreaseProgram sizeafterthe increaseTotal size About 50 About +5 About 55Asset purchases 15.0 +5.0 20.0JGB* 4.0 +5.0 9.0T-Bill 4.5 -- 4.5CP 2.1 -- 2.1CB 2.9 -- 2.9ETFs 1.4 -- 1.4J-REITs 0.11 -- 0.11Fixed-rate funds-supplying operationagainst pooled collateral35.0 -- 35.03-month term 20.0 -- 20.06-month term 15.0 -- 15.0* = In addition to purchases under the Asset Purchase Program, the Bankregularly purchases JGBs at the pace of JPY 21.6trn per annum.Source: BoJ, BNP ParibasSell JPY →←Buy JPY543210-1-2-3Chart 2: USD/JPY and FX Intervention(¥trn)95 97 99 01 03 05 07 09 11 CYSource: MoF, BNP Paribas8070605040FX intervention¥4.5trn (4-Aug)USD/JPY(RHS)Chart 3: Banknote Rule (JPY trn)30CY 99 01 03 05 07 09 11Source: BoJ, BNP ParibasBoJ notes in circulationCurrent depo.(RHS)QuantitativeeasingBoJ holdingsof JGBs150140130120110100and performed well after our recommendation ahead ofthe 5y auction last week. Also, today’s BoJ decisionmay support the 2y sector, against our position.908070403020100Tomohisa Fujiki 27 October 2011Market Mover50www.GlobalMarkets.bnpparibas.com