All eyes and ears will be on Ben Bernanke and the Federal Reserve tomorrow as it wraps up its two-day Federal Open Market Committee (FOMC) meeting and updates us on the direction of monetary policy.
Investors and traders will be listening for any clues regarding the “tapering,” or gradual reduction, of the Fed’s quantitative easing, or bond-buying, program.
In a research note to clients today, Societe Generale’s Alain Bokobza looks back at Japan’s experience with QE tapering in 2006.
“In March 2006, the Bank of Japan (BoJ) announced the exit from QE, amid signs that activity was accelerating and the economy was emerging from deflation,” noted Bokobza. “The BoJ exit provides interesting insights regarding what we may expect from the Fed in the coming quarters.”
During the quarters around the end of QE, 10y Japanese Government Bond (JGB) yields increased by almost 100bp; from 1.1% at mid-2005 to 2.0% in May 2006.
The Nikkei declined by 20% between April and June 2006 after having increased by 60% in the preceding 12 months (see chart). The sell-off was nonetheless short lived.
The exit from QE in Japan was conducted in just 3-4 months, mainly by reducing the amount of bills purchased from private banks, i.e. the most flexible asset on the BoJ’s balance sheet. Holdings of longer-term JGBs were reduced very slowly and moderately; the BoJ actually kept in place its regular purchases of longer-term JGBs. The BoJ also implemented liquidity operations to ensure the stability of interbank money markets.
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