Where next for the Japanese Yen and the Bank of Japan?

As the third most traded currency the Japanese Yen is one of the bedrocks of the world economy. In spite of the size and strength of the Japanese economy the currency tail can wag the economy dog as we saw on the period of the “Carry Trade” and its consequences. For newer readers I looked at the initial impact back on the 19th of September 2016.

 Ironically if done on a large-scale as happened back in the day with the Swiss Franc and the Japanese Yen it lowers the currency and so not only is the interest cheaper but you have a capital gain. What could go wrong? Well we will come to that. But this same effect turned out to make things uncomfortable for both Japan and Switzerland as their currencies were pushed lower and lower.

At that point borrowers were having a party as the got a cheaper borrowing rate and a currency gain but the Japanese ( and Swiss) saw their currency being depressed. However the credit crunch ended that party as currency traders saw the risk and that people might buy Yen to cover the risk. Thus there was a combination of speculative and actual buying which saw the Yen strengthen from over 120 Yen to the US Dollar to below 80.

There were various impacts from this and starting in Japan life became difficult for its exporters and some sent production abroad as the mulled an exchange rate of around 78 to the US Dollar. For example some shifted production to Thailand. Looking wider the investors who remained in the carry trade shifted from profit to loss. On this road in generic terms the typical Japanese investor often described as Mrs. Watanabe was having a rough patch as in Yen terms their investments went being hit. Actually that is something of a generic over my career for Mrs Watanabe as timing of investments in say UK Gilts or Australian property has often been poor. Of course as it turns out property in Oz did work but you would have needed plenty of patience.

Enter the Bank of Japan

The next phase was a type of enter the dragon as the Bank of Japan in 2013 embarked on an extraordinary monetary stimulus programme. Under the banner of Abenomics that was designed to weaken the Yen although it was not officially one of the 3 arrows it was supposed to fire. For a while this worked as the Yen fell towards 125 to the US Dollar. But just as economics 101 felt it could celebrate a rare triumph the Yen then strengthened again and actually rallied to 101 in spite of negative interest-rates being deployed  leading to yet another new effort called QQE and Yield Curve Control in September 2016.

So we see that Japan had some success in weakening the Yen but that then ended and even with negative interest-rates and the purchases by the Bank of Japan below there was a fizzling out of any impact.

The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen.

But you see these things have unintended consequences as Brad Setser points out below.

Japanese investors have been big buyers of foreign bonds—and U.S. bonds in particular. The lifers, the Japanese government through the government pension fund (GPIF), the Japanese government through Post Bank (which takes in deposits and cannot make loans so it buys foreign bonds since it cannot make money buying JGBs), and Norinchukin*

So a policy to weaken the Yen has a side-effect of strengthening it and even worse makes the global financial system more risky. Back to Brad.

In broad terms, a number of Japanese financial institutions have become, in part, dollar based intermediaries. They borrow dollars from U.S. money market funds, U.S. banks, and increasingly the world’s large reserve managers (all of whom want to hold short-term dollar claims for liquidity reasons) and invest in longer dated U.S. bonds.

What about now?

Things are rather different to this time last year when we were trying to figure out what had caused this?

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………. ( Reuters )

That was from January 3rd whereas overnight we see this.

The major was trading 0.1 percent up at 110.09, having hit a high of 110.21 earlier, its highest since May 23.  ( EconoTimes )

On its own this may seen the Governor of the Bank of Japan have a quiet smile and a celebratory glass of sake. But falls in the Yen are associated with something else which will please the head of The Tokyo Whale.

TOKYO (Kyodo) — Tokyo stocks rose Tuesday, with the benchmark Nikkei index ending above 24,000 for the first time since mid-December, as investor sentiment improved on expectations for further easing of U.S.-China trade tensions. ( The Mainichi)

The Mainichi seems to have missed the currency connection with this but no doubt Governor Kuroda   will be pointing out both thresholds to Prime Minister Shinzo Abe.

Has something changed?

On Monday JP Morgan thought so. Via Forex Flow.

But because in recent years the yen is no longer being sold off in the first place, it is not acting as much like a safe-haven currency as in the past.

Okay so why?

if interest rates increase in other countries (opening a wider gap with rates in Japan)

Well good luck with that one! Maybe some day but the credit crunch era has seen 733 interest-rate cuts. However the Financial Times has joined in.

First, Japan is running trade deficits, which would imply a weaker currency. Second, domestic asset managers are busy buying higher-yielding foreign assets. Third, Japanese companies, confronting a chronic shortage of decent ways to deploy their capital at home, are increasingly spending it on deals overseas.

The last point is a really rather devastating critique of the six years of Abenomics as one of the stated Arrows was for exactly the opposite. Also there us more trouble for economics 101 as a lower Yen has seen a trade surplus switch to a deficit. Actually I think that responses to exchange rate moves can be very slow and measured in years so with all the ch-ch-changes it is hard to know what move is in play.

Comment

There is much to reflect on here. For example today may be one to raise a smile at the Bank of Japan as it calculates the value of its large equity holdings and sees the Yen weaken across a threshold. But it is also true that exactly the same policies saw the “flash rally” of over a year ago. In addition we see that the enormous effort in play to weaken the Yen has seen compensating side-effects which raise the risk level in the international finance system. Really rather like the Carry Trade did.

A warning is required because in the short-term crossing a threshold like 110 Yen sees a reversal but we could see the Yen weaken for a while. This is problematic with so many others wanting to devalue their currency as well with the Bank of England currently in the van. From a Japanese perspective this will be see as a gain against a nation they have all sorts of issues with.

“China has made enforceable commitments to refrain from competitive devaluation, while promoting transparency and accountability,” US Treasury Secretary, Steven Mnuchin, said.

President Donald Trump has repeatedly accused China of allowing the value of the yuan to fall, making Chinese goods cheaper.

But, on Monday, the US said that the value of the yuan had appreciated since August, at the height of the trade war. ( BBC )

How will that play out?

 

 

 

12 thoughts on “Where next for the Japanese Yen and the Bank of Japan?

  1. Hi Shaun

    Great article as always. As an aside, the banks are starting to drop rates in anticipation:

    https://www.bbc.co.uk/news/business-51106886

    And Taylor Wimpey announced this:

    We remain a very cash generative business and, as previously announced, intend to return £610 million to shareholders by way of total dividend in 2020. This is after the payment of c.£600 million of dividends to shareholders in 2019 (2018: £499.5 million).

    https://www.investegate.co.uk/taylor-wimpey-plc–tw–/rns/trading-statement/202001140700056661Z/

    You can see the main beneficiaries of the boe’s policies 😉

    thanks

  2. Great blog as usual, Shaun.
    The St.Louis Fed database’s most recent datapoint for the quarterly Japanese residential property price index (RPPI) is only for 2019Q2, but it shows an annual inflation rate of 2.1%, down from 2.3% in 2019Q1, so real property prices are rising, but we are hardly in bubble territory.
    Speaking of the Fed, not much attention seemed to be paid to Paul Volcker’s death at the end of 2019. His death was anticipated, and the publication date of his excellent memoir “Keeping At It” was pushed up so that he would still be around for its release, but it is still sad news. When he was doing interviews for his memoir Volcker said about the US Fed’s two-percent inflation rate target: “They made up the 2 percent number. One of the reasons I wrote this damn memoir is I get upset when I hear them fighting over whether 1.75 percent is enough inflation.”

    • Hi Andrew and thank you

      Your reply got me to look for a more up to date index for house prices. The one from the Ministry of Land Infrastructure and Transport or MLIT is showing an annual rise of 1.7% in September of last year. The year has been inconsistent but generally upwards and the index set at 100 in 2010 was 113.2 in September.

      However there are wide variations as the condominium index was at 147 showing an annual rise of 5.7% but detached houses were showing a fall of 2.1% and the index for them is at 101.2 so might see its own lost decade. Quite a difference!

      “Based on transaction price information on approximately 300,000 real estate properties per year, we publish a monthly “Real Estate Price Index” that indexes real estate price trends by country, by block, by metropolitan area, and by prefecture.”

  3. The Japs just can’t get this depreciation thing right can they? They can manufacture anything, but to repeatedly devalue your currency requires the skill of the Bank of England, since the end of 2007, the pound is down 35% against the dollar and a massive 43% against the Yen.

    If you go back further the true extent of the damage becomes apparent from 1975 it has lost 45% against the $ and 80% against the Yen, and with a potential hard BREXIT likely at the end of the year, much more is to come, what were the words of Harold Wilson after the devaluation in 1967- “this will not affect the pound in your pocket”?!!!!

    • I always wonder at the logic of devaluing your currency when your economy is 80% service based . It has not be demonstrated over a period of decades now that it helps the manufacturing part or the rest of the other 20% …

      As we import almost everything then logic would dictate that a rising value would help boost the service sector more than any perceived damage to the other 20%

      unless of course there is another reason…..

      Forbin

  4. Pingback: Where next for the Japanese Yen and the Bank of Japan? – Investment Watch – Bear News

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