It was all about the yen on Thursday, when the Bank of Japan surprised markets with a pledge to buy unlimited amounts of JGBs at fixed-rate ops every business day if necessary.
The decision conveyed an ironclad commitment to the bank’s 0.25% cap on 10-year yields, which the BoJ was forced to defend earlier this month as global bonds sold off. Defense of the cap in perpetuity suggests the monetary policy divergence between Japan and the US will persist, giving the yen carte blanche to fall further.
And fall it did, sinking past 130. When USDJPY breached 131 (figure below) the Ministry of Finance verbally intervened. Recent FX moves are cause for “extreme concern,” an official said, adding that “appropriate action” would be taken if needed. It’s important, the same official reiterated, that the yen moves “in line with fundamentals.”
Of course, if yield differentials and monetary policy disparities count as “fundamentals,” you could argue the yen is doing just that. The rapidity of the policy divergence as measured by yield differentials is remarkable (figure below), even as the spread itself isn’t.
Amusingly, Haruhiko Kuroda said he doesn’t believe the BoJ’s Thursday decision encourages yen weakness beyond what might’ve been justified by existing policy. Suffice to say the market didn’t concur.
A weak yen can be a good thing for the economy, as Kuroda was keen to emphasize, but there are side effects. The yen’s slide is exacerbating an already deleterious trend in Japan’s trade balance, for example. A string of monthly deficits serves as another reason to be JPY bearish, and with energy prices surging, the ongoing slide in the currency is an amplifier. It’s also problematic for retailers to the extent consumers’ deeply entrenched deflationary mindset makes it impossible to pass along surging input costs.
Read more: Yen Sanity
Kuroda has the government’s blessing to persist in a dovish bent in the interest of stoking inflation, but the fact that the Finance Ministry was compelled to intervene just hours after the BoJ decision on Thursday spoke to the tension inherent in competing priorities. It also had a slapstick feel to it, which traders undoubtedly picked up on.
Cost-push inflation isn’t sustainable in Japan, Kuroda said, noting that wages aren’t rising enough. Monetary policy can’t be normalized, he mused, as long as the country’s recovery lags the rebound in other developed markets, particularly the US and Europe. He suggested the tweak to the BoJ’s bond-buying approach is aimed at reducing speculation about when the bank would intervene to cap yields. That’s become a parlor game of sorts whenever the 10-year flirts with 0.25%. The BoJ, Kuroda insisted, will defend the cap “every day” if necessary.
Some have asked whether Japan will be forced to abandon yield-curve control, RBA-style. My answer, as discussed here last week, was: “No. Definitely not.” Kuroda underscored that Thursday.
This only heightens the risk of an Asia FX war. The yuan, the subject of intense market scrutiny of late, fell sharply against the dollar. USDCNH breached 6.65. The onshore yuan traded through 6.61.
“We’re surprised the PBoC has let USDCNY trade through 6.60,” ING’s Chris Turner said, noting that it was just three days ago when Beijing stepped in to slow the pace of depreciation.
Read more: A Currency War May Be Coming To Asia
“An unexpected adjustment in USDCNY is keeping USD/Asia bid — a move supported by a dovish Bank of Japan today,” Turner added, underscoring the rising odds of a currency conflagration.
Both the Aussie and the kiwi hit multi-month lows as the BoJ decision prompted basket-buying of the dollar across G10 pairs. “[The] selling incentive is so strong that it’s impacting other currencies through dollar-buying,” an economist at Mizuho remarked.
This situation is combustible. And I’d note that the read-through for markets from the attendant dollar strength is ambiguous at this juncture. One thing we know: Too much dollar strength over compressed time frames combined with (and exacerbated by) hawkish Fed policy can be destabilizing.
Thank you for the article. If there’s competitive devaluation in Asia with a surging US dollar, what would be the secondary effect or indicator to look for before something snap?
I have been watching Japan for lo these many years. Their solutions to economic problems are very short term and not geared to addressing their real problems. They have never fixed their banking system. It needs to be fixed with more capital- and they need to finally write off bad debts. Even more importantly, they need to fix their demographic problem. That means a family friendly policy, and a policy which fixes gender discrimination so a woman can work and raise a family with support (sound familiar). They need to fix their misallocation of land- too much land is dedicated to farming close to cities which desperately need better housing for families (suburbs!). A more liberal policy to allow more immigration would also help. (Do many of these comments look applicable to the USA? You betcha – Japan just has it worse in many respects)…..Monetary and FX policy for Japan is a bandaid which has long failed the country. They need to change badly.