The Bank of Japan continues to play alone in these times of global inflationary pressures by keeping monetary policy ultra accommodative as the rest of the world tightens. As a result, the yen weakens as Japanese food and energy import costs soar.
For the first time in decades, Japan is facing strong inflationary pressures. Although this should have led to higher bond yields, Japan cannot afford high debt service charges due to the country’s huge debt burden (>250% of GDP). As such, the BoJ uses a mechanism known as yield curve control (YCC) where it continues to buy JGBs (Japanese government bonds) to ensure that yields do not exceed a upper limit of 0.25% for the 10-year JGB.
However, macro hedge funds and other investors are now betting that YCC is unviable and thus selling the JGB market short – much in the way hedge fund manager George Soros attacked the pound in the 1990s. The BoJ is forced to buy even more JGB to defend the hard limit of 0.25%.
Japanese monetary policy is way beyond normal
“The pace of BoJ purchases has accelerated to a monthly pace that is now double the pace of ‘Abenomics peak’ purchases of around 20 trillion yen in government bonds,” explained Charles-Henri Monchau, director of investments of the Syz group. “That’s the GDP equivalent of the Fed doing $750 billion in monthly QE in the United States.”
The only way the world can begin to reverse monetary policy from the emergency level, while simultaneously running record debt and deficits, is for the Bank of Japan to implement unlimited, full-throttle QE. In doing so, the BoJ has become the shock absorber of the global economy. In return, they can devalue the yen and devalue the worst debt burden in the world.
With this policy divergence and the implied permission to devalue the yen, the yen has fallen more than 17% since the Fed made its first rate hike in March. By April, he had already been on a record losing streak. It hit new 24-year lows against the dollar.
“One of the reasons the Bank of Japan is maintaining a radically different course than other central banks is the belief of policymakers that the current inflationary pressures in Japan will be temporary,” he said. Richard Aston, manager of the CC Japan Income & Growth investment fund. “We remain cautious but note the announcements of Asahi Holdings Group that the prices of national products (beer and soft drinks) will be increased between 6% and 10% (the first increase in 14 years) and by the convenience store operator Lawson that it will raise the price of its popular fried chicken (“kara-age”) for the first time in 36 years. Supporting these movements, data shows that input costs (as measured by the PPI) are rising at the fastest rate since 1980, while consumer inflation expectations are at 14-year highs.
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Is it just the giant Ponzi scheme?
Some other commentators refer to the BoJ policy as a “giant Ponzi scheme”. As a result of the above, the BoJ is obligated to lend the equivalent amount. This then triggers what usually happens when investors get ultra-low funding in an ever-weakening currency: lots of carry trades. But if the yen strengthens and/or the yield rises (due to the BoJ’s eventual abandonment of the YCC), we will have a massive unwinding of carry trades, i.e. a massive market sell-off. .
“The Bank of Japan’s renewed policy of keeping 10-year bond yields below 0.25% helped push the yen to a 20-year low against the dollar at a time when interest rates US Fed increase,” observed Taeko Setaishi, manager of the investment fund Atlantis Japan Growth. “This is having a negative impact on Japan in terms of raw material imports, especially with soaring energy costs globally. At a time when real wages have increased only marginally, the he impact on Japanese households will be hard felt.While the headline inflation rate is expected to remain below that of other developed economies, it will be a shock to an economy that has experienced stubbornly low inflation for more than 20 years.
The BoJ is thus playing with fire and the risks go well beyond the Japanese islands. The weakening of the yen creates the risk of currency devaluation across Asia (which will trigger higher inflation and higher dollar debt costs and hence default risk) while existing carry trades could create a global shock the day they unravel. This is a ticking time bomb in the making that FX traders will need to watch closely, even if they are trading outside the JPY.
“It’s the kind of financial crash (led by tighter monetary policy in the U.S. versus easing in Japan) that could indeed lead to further market declines and a global recession,” he said. said Monchau. “Something to watch carefully.”
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