As the Bank of Japan transitions from 23 years of quantitative easing ( QE), Xi Jinping’s inner circle in Beijing is probably breathing a little easier.
On Tuesday ( March 19 ), BOJ Governor Kazuo Ueda ended the world’s next bad interest rate program and scrapped Tokyo’s produce- curve- control experiment.
Its new range for policy rates is between 0 % and 0.1 %, pivoting away from the previous -0.1 % target. The BOJ’s action was basically the smallest it could have taken without upending , international businesses.
The fact Ueda’s team stresses that credit conditions may remain flexible suggests this is largely , a metaphorical move with some huge economic consequences. However, the BOJ’s exceedingly delayed effort to restore rates today begins in earnest.
Yet you can imagine Beijing is paying close attention. No plan action will cause an financial tailwind for China and, conversely, recession much more quickly than a weaker exchange rate. The yuan lower has been pushed aside by President Xi’s staff to prevent unsettling international buyers.
Internationalizing the renminbi has been a major Xi concern for the past eight years. Changing the exchange rate may waste that advancement. And bring Washington’s indignation as a controversial US election approaches. Team Xi will be cheered up by the threat of a stronger yen below.
According to scholar Louis Gave at Gavekal Dragonomics,” China policymakers— and economic markets— you breathe a sigh of relief” given that the BOJ is abandoning its zero-interest-rate plan and produce curve control.
It stands to reason that the business for China’s goods may be other emerging markets as Xi and Premier Li Qiang labor to move growth engines from home and funding to technology and higher-value-added industries.
Selling cars, solar panels, batteries, trains, turbines, power plants and high- tech infrastructure will be easier as the currency of Asia’s No 2 economy appreciates.
” If the yen should start to rise, the outlook for China will improve dramatically”, Gave says. ” Policy, geopolitics and financial markets will all start pointing in the same direction”.
Risks abound, of course, for Tokyo. One is Japan’s ability to maintain the monetary tightening since 2007, the last time the BOJ attempted to alter monetary policy.
In the second half of 2023, Japan hardly managed to avoid a recession. The economy lost 3.3 % of its GDP in the July-September quarter, down 3.3 % from the previous quarter, and only eked out 0.4 % in the final three months of the year.
In January, household spending plunged , 6.3 % from a year earlier, the sharpest drop in 35 months.
The bull case for Japan centers on the results of this year ‘s , shunto , wage negotiation. On Friday, the Japanese Trade Union Confederation, or Rengo, announced an average 5.28 % pay hike, the fastest increase in 33 years.
According to economist Jonathan Garner of Morgan Stanley MUFG,” this can be described as a virtuous cycle of rising nominal GDP growth, wages, prices, and corporate profits.”
Stefan Angrick, economist at Moody’s Analytics, adds that” after a dreadful run of economic data through 2023, the , shunto , surprise is the first good news in a long while. What should be closely watched in the coming weeks is how these negotiated pay increases affect consumer spending and wage increases across the economy.
However, it is still unclear how Japan Inc. will react if the BOJ removes the monetary training wheels from the country’s most developed country’s highest debt burden.
Corporate Japan has been making money since the BOJ cut interest rates for the first time in 1999. Even more so in 2000 and 2001, when the central bank was the one to institute QE.
Since then, the US, Europe, UK, Australia and other major economies also went the QE route, mostly in response to the 2008 Lehman Brothers crisis. Since QE’s termination, all have started normalizing rates. Except Japan.
Until Tuesday, of course. Ueda now has the power to reduce the BOJ’s balance sheet without hurting the economy or causing a global market panic.
One risk is the so- called “yen- carry trade”. Japan became the most important creditor after roughly a quarter century of zero interest rates.
Investors started using cheap yen to borrow money and put those funds into higher-yielding assets all over the world. Strong zigs in the yen can result in hefty zigs in Seoul’s and New York’s markets.
Hence the BOJ’s caution in stepping away from QE more decisively. Finding a way to leave the Japanese stock market and bond market without creating chaos is a part of Ueda’s challenge.
Under Ueda’s predecessor, Haruhiko Kuroda, the BOJ amassed a titanically large balance sheet. First, it bought up more than 50 % of all outstanding Japanese government bonds ( JGBs ). Its dominance over the market grew to the point where not a single security can no longer be traded hands.
Next, the Kuroda BOJ seized control of the stock market with massive exchange-traded fund purchases. It became the biggest “whale” in Tokyo shares, bigfooting even the US$ 1.6 trillion Government Pension Investment Fund.
By 2018, the BOJ had surpassed the size of its US$ 4.7 trillion economy in terms of its balance sheet, which set a new record for the BOJ in central banking circles. No economist or investor can predict the outcome of the BOJ’s unwinding process and where the risks lie for the markets and economy.
What transpired the last time the BOJ attempted to raise rates is a recurring issue for Ueda’s team? Back in 2006 and 2007, then- governor Toshihiko , Fukui managed to end QE and cajole fellow board members to raise official rates twice.
It did n’t go well. The political and corporate elites of Japan vigorously opposed the Fukui BOJ. Soon after, the economy slid into recession. Masaaki Shirakawa’s first priority was to restore QE and reduce rates back to zero when he took over Fukui in 2008.
Then, in an effort to end deflation, Kuroda superseded BOJ stimulus efforts. In 2013, the year Kuroda took the helm, the Nikkei 225 Stock Average surged 57 %. And it kept rallying, to the point where the benchmark is now trading near its all- time 1989 high.
Though the Nikkei’s 49 % jump over the last 12 months partly reflects improving corporate governance in Japan, the BOJ’s largess is a major driver. The difficult part is only just beginning, so it follows.
How the wider financial system will withstand rising JGB yields is a subject for debate. If 10- year rates rose to, say, 2 % or even 3 %, no one can say what it might mean for banks, companies, local governments, pension and insurance funds, endowments, universities, the postal system and retirees.
The main financial assets that these interests and others have are JGBs.
For years, economists buzzed about a “mutually assured destruction” dynamic with which Ueda’s team must not contend. The other problem is related to the roughly 265 % of GDP-emitting nation’s debt. Given Japan’s shrinking and aging population, any surge in borrowing costs would alter the fiscal calculus for Prime Minister Fumio Kishida’s administration.
The onus now is on Kishida’s government to accelerate economic reforms to cut bureaucracy, modernize rigid labor markets, rekindle innovation, increase productivity and empower women. The vast majority of Japanese businesses will be affected by these decisions and others.
According to Howe Chung Wan,  , head of Asian fixed income at Principal Asset Management,” the wage growth we have seen, especially from the Rengo wage talks, has given confidence that this opportunity is to end the zero-interest rate policy with the support of government officials.”
He asserts that” Japan large corporations still have room to raise pay, given corporates ‘ sales and revenues are up higher and their pay still has room to catch up.” There will come a point when corporate margins will be slack due to higher pay, but that’s at least another year later. Smaller companies, however, may not have the same ability to pay what large corporates do”.
Given the sluggish pace of economic developments in Tokyo, Ueda arguably has the hardest job in global economics. The fragile state of Japan’s regional banking system is one of his biggest challenges. Namely, the risk of a Silicon Valley Bank– like blowup amongst Japan’s 100- plus regional lenders.
SVB’s crash in early 2023 is back in the news as New York Community Bancorp stumbles. Japan’s extensive network of medium-sized lenders provides assistance to rapidly aging populations in sparsely populated regions of the nation. That severely reduced profits before the banking woes of the past 15 years, including the effects of the global crisis of 2008, fell.
The relocation of Japanese businesses and talent to Tokyo has left less business to do. Despite hard times, Japan’s regional banks have been reluctant to merge, perpetuating this financial overcapacity.
Many people spent the last ten years hoarding government and corporate bonds instead of lending the BOJ’s credit because profit opportunities were limited. Similar actions led to the destruction of SVB and Signature Bank in New York.
In September, Japan’s Financial Services Agency announced plans to stress- test at least 20 banks to surface any SVB- like landmines across the nation. The specter of similar bankruptcies that are fueled by social media is a part of the issue.
The global financial system will be kept on its toes by the wider repercussions of a BOJ error, though.
There have been instances in the past decade where changes in Japanese government bonds have had a significant impact on the overall bond market, according to Padhraic Garvey, economist at ING Bank.
There are two elements to watch, Garvey says. ” First, the likely unshackling of the 10- year JGB opens a vacuum to the upside, and an issue is how far into that vacuum do JGBs venture”, he notes.
Second, the carry trade, which has boosted performance of spread for an extended period of time, has been loosened by the ultimate policy tightening of the reins on the front end.
Garvey continues,” Our gut tells us that longer-term rates have more room for movement than the policy rate, but moves are unlikely to be significant.”
For now, traders and investors are scrutinizing the BOJ’s every utterance for hints of what’s ahead. So far, Ueda’s team is n’t saying much.
We are monitoring any developments at the long end of the curve – maturities over 10 years and change in demand for overseas bond investments, according to Kensuke Niihara, Japan’s chief investment officer at State Street Global Advisors.” We are monitoring any developments at the long end of the curve – maturities over 10 years.
China, which stands to gain a lot from a rising yen this year, is undoubtedly more interested in that forward guidance from Tokyo, despite the fact that it is undoubtedly no major economy. China could become the real winner as the BOJ finally decides to end its QE campaign if Beijing policymakers do n’t lift a finger.
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