“The new generation of Mrs.Watanabes and Investing today in Japan” (PART -2)
AV: With the BOJ still imposing yield curve control by capping JGBs while the Fed has increased interest rates and hence widening credit spreads; is the three sigma decline in the Dollar / Yen ratio the knock on effect of this policy or is there also some idiosyncratic risk with the current Dollar / Yen ratio?
YB: The recent move in the yen has to be viewed in terms of a longer-term perspective in addition to the current yield differential driving the recent yen weakness. The very long-term trend has been a strengthening of the yen throughout the high economic growth period Japan experienced in the 1960s, which accelerated post plaza accord in the 1980s.
Currently, the yield differential is again driving the yen. Japanese inflation is likely to surge from April as the downdraft from mobile-phone prices drops out; that inflation surge could add further weakening pressure to the yen. However, it is worth noting that the real yield differential drove the yen until the end of 2017 and again after June 2020; between the two periods, the correlation with real yields was terrible.
The current account is another major driver of the yen. Japan had a strong current account surplus till the 11 March 2011 earthquake took out its nuclear-generating capacity. That forced it to import vastly more hydrocarbon fuels. A continued sharp increase in the yen cost of crude oil could well weaken the trade balance further, depressing the current account. Current account weakness and the widening yield gap together argue for further weakness in the yen - unless and until the government restarts mothballed nuclear plants. Slowing US growth or a transient inflationary outcome in the US could temper this by slowing the rate of US rate rises. China growth deceleration could also help tame inflation expectations, particularly on primary commodities and energy supply constraints. Criticism from the US and other trade partners historically has tended to halt weakness of the yen. In contrast the recent supposed request for coordinated intervention to stem the yen weakness by Japanese Finance minister Suzuki aimed at Janet Yellen and the FED seems to have been met with resistance at the recent G7 meeting.
AV: Japan is the largest holder of UST, and if yield curve control is abandoned by the BOJ, what is the net effect of the USD / JPY?
The current global macro set up is a “once in a lifetime” opportunity for Japan to escape a multi decade deflationary straightjacket. It has also been a career aim for BOJs Kuroda who is relatively shortly to retire (April 2023) and thus it is likely that we will have to wait until at least then to see some U turn from BOJ regarding yield control. It is more likely we will see currency intervention rather than a BOJ policy U turn first.
AV: So, the 64,000 question is given the speed of the decline of the Dollar / Yen ratio, will the Japanese government intervene and if so, at what level?
YB: The pace of yen weakness is clearly creating some political fallout domestically as consumers react to price rises not seen for over a decade in most product and service categories. This goes beyond the globally problematic energy pricing: For example, taxi fares have not risen in Tokyo for 15 years until the recent price hike and Asahi beer prices since 2008 (14). The approval rating of the Kishida government has actually taken an uptick with COVID reopening and the LDP is likely to want to build on rather than sacrifice those gains. Thus, it appears that intervention is likely though problematic in terms of level and effect. The latter it is widely agreed is temporary until fundamental macro factors alter. There are numerous precedents beyond Japan and the yen. Thus, buying time is the best realistic outcome (until Kuroda retires or faces unlikely politically forced step down) and thus to do this paradoxically the pace of yen weakness has to accelerate first in order to make the reversal intervention “squeeze” be meaningful in order to deplete short term speculators in the trade albeit temporarily.
In this context technical levels and the environment associated with them become important. The timestamps all belong to a period beyond most participants employment in Japanese financial markets.
1. 134.68. 31 /01/2002
Capitulation phase of “Dotcom bubble” selloff. Some paralells with recent US tech selloff
2. 144.66 14/7/1998
The start of Japan’s structural deflationary period starting with a required recapitalization of the Japanese banking sector in 2003 after the “lost decade” of the 1990s where stagnating problem loans to “zombie” corporates were allowed to fester on loose mark to market practices. Yamaichi securities bankruptcy in Nov 1997 was the first portent of this period to come.
3. 158.85 30/04/1990
32 years ago, and short-term trough of Nikkei from first selloff from peak of stock Market in December 1989.
Intervention could occur at any of these levels although likely beyond the first and before the second in my view to create the sort of squeeze required to get a temporary reversal.
AV: As a net importer and with the recent magnitude of changes, what successful fiscal policy moves can the BOJ implement?
YB: No measures likely. We are likely to see further fiscal packages announced by the government, though with little “real water”