Bank of Japan loses control as QE hits the limits

'This could go down in the history books as the death of Abenomics'

By Ambrose Evans-Pritchard


Events are going horribly wrong for Haruhiko Kuroda, Governor of the Bank of Japan 
 
 
The Japanese yen has become the lightning rod of extreme stress in the global financial system, rocketing this week in violent moves that threaten to plunge Japan back into deep deflation and overwhelm the experiment of "Abenomics".

The currency has appreciated by 9pc against the US dollar since the Bank of Japan (BoJ) cut interest rates below zero for the first time ever at the end of January, entirely defeating the purpose.
 
The yen broke through ¥111 in early trading on Thursday as safe-haven flows poured into the country and vast positions were unwound on the global derivative markets. This wiped out all the depreciation effects of the country’s "weak yen" policy over the past 15 months. The Nikkei index of stocks in Tokyo has fallen 22pc since early December.
 
The drastic developments have been nothing less than a disaster for Governor Haruhiko Kuroda who pushed through negative rates against strong protests by half the bank’s voting members. The chief motive for the move was counter deflation by weakening the currency.
 
“This is a reverse policy shock. We are reaching the limits of quantitative easing as we know it,” said David Bloom, currency chief at HSBC. “Countries are losing their ability to drive down their currencies.”

The Bank of Japan bought vast amounts of US Treasuries in 2003 in direct intervention to devalue the yen but any such action in today’s neuralgic markets would trigger accusations of currency warfare. It would violate a solemn accord by G20 leaders prohibiting the use of QE for exchange rate purposes.

Mr Bloom said there is almost nothing the Bank of Japan can do to stop inflows of money in any case. “The Swiss spent €150bn over four months to hold down the franc and achieved nothing in a market that is 14 times smaller,” he said.

Japan is already in the grip of deflation. Producer prices fell 3.1pc in January. The economy almost certainly contracted in the fourth quarter. “Japan’s economy is in a very dire situation,” said Yoshiki Shinke from Dai-ichi Life.

The surging yen tightens the noose further, calling into question the whole strategy of premier Shinzo Abe, the strongman who swept into office three yeas ago with bold plans to break the country’s deflationary psychology once and for all.

“This could go down in the history books as the death of Abenomics,” said Neil Mellor from BNY Mellon.  

“Abe cannot stand aside and let the project die like this. But negative interest rates have backfired and hurt the banks, so what are they going to do next?” he said.

Abenomics never lived up to its billing, although QE did succeed in driving the yen to its lowest level in trade-weighted terms since the early 1980s. It also led to windfall profits for Japanese companies, but little was put to use or passed through in higher wages.

The crucial "third arrow" of Thatcherite reform hardly flew at all. A premature rise in the consumption tax tipped the economy back into recession before it had reached "escape velocity".

The yen is closely-watched by traders as a global stress indicator. It has spiked wildly at the onset of each global upheaval over the past three decades, including the East Asian crisis in 1998 and the Lehman crash in 2008.

This odd dynamic occurs because Japan is the world’s biggest net creditor by far, with net assets of $3.5 trillion overseas equal to 72pc of GDP, a ratio comparable to that of Switzerland and Norway but on a vastly greater scale.

The Japanese tend to bring their money home whenever they lose confidence in global markets, typically closing "carry trade" positions en masse and sparking an explosive collective impact.

Hans Redeker, head of currencies at Morgan Stanley, said Japanese funds have record levels of “unhedged” assets in the US that are suddenly at risk as the US Federal Reserve retreats from monetary tightening and yields plummet on US Treasuries. “Value at risk is coming into play and this is forcing funds to cut back,” he said.

The 10-year yield on US Treasuries has plummeted to 1.57pc from 2.31pc six weeks ago, with similar moves across the yield curve. This has obliterated the crowded "long US" trade so popular in Japan. The proverbial “Mrs Watanabe” – Japan’s day-trading housewives and grannies – are famed for playing the global markets with too much leverage and gusto.

The yen syndrome has been amplified by the effects of QE. The Bank of Japan has been buying $70bn of bonds each month, effectively monetising the entire budget deficit. It is has gobbled up 33pc of the country’s $9.3 trillion public debt.




This has pushed Japanese banks, life insurers and Japan’s $1.2 trillion pension fund (GPIF) out of government bonds and into foreign investments, a deliberate strategy to force down the currency. The snag is that this tightens the elastic. It can snap back ferociously, as we have seen this week.

Kenji Abe from Bank of America said the BoJ could cut rates to -1pc, a move that would drive the 10-year bond yield from zero to -0.8pc under the bank’s model. This would, in theory, lift corporate earnings by 5pc and set off a stock market rally.

Kazumasa Iwata, the former deputy governor of the BoJ, said rates could drop to -2pc, uncharted territory even in the current topsy-turvy world. There comes a point when even large investors switch to cash instruments.

It is unclear what more can be achieved by tinkering with interest rates. The Bank of Japan might gain more traction by expanding its purchases from real estate "REITS" and exchange-traded funds to a broader range of securities, injecting money into the veins of the stock market.

Ultimately, the BoJ and its peers in Europe and the US may have to resort to variants of "helicopter money" and the blanket funding of New Deal programmes to counter the next recession. None is yet ready to cross the Rubicon, and the markets know it.

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