BOJ: FX Jitters and Shifting Targets

Published on February 25, 2019

On Friday, February 22, Bank of Japan Governor Haruhiko Kuroda met with Prime Minster Shinzo Abe. While there is nothing unusual per se about a central bank head briefing his head of state, this was the first meeting between the two since June of last year, and that has raised some eyebrows in Tokyo.

** Sources in Japan suspect Kuroda and Abe may have discussed the “TAG” (Trade Agreement on Goods) and potential tensions with the US over “Exchange Rate Practices” at their meeting, with a wary eye on currency talks that have emerged as an integral part of trade negotiations between Washington and Beijing. They fear the US will demand Japan refrain from intervening in the FX markets, which is not far from standard G20 protocol. But the concern now at the Bank of Japan is that the US may also try to bind its monetary policy with a demand that it refrains from providing further monetary easing explicitly to push down the yen. 

**In light of that, the timing of Kuroda’s comments last week to the Japanese Diet seems particularly unfortunate. In what may have seemed the safe zone of one of many testimonies to Parliament, the battle-weary Kuroda, on February 19, assured members of the Committee on Financial Affairs of the Lower House (House of Representatives) — who were worried about a potential appreciation of the yen — that the BOJ could clearly counteract a strengthening currency with monetary easing. Some things, even if understood by all, are better left unsaid.

** Kuroda’s remarks did push down the yen against major currencies, but only by a very limited amount, and for a short period of time. Despite assurances by Kuroda that there is always, if needed, more juice to be had, the BOJ remains stuck between a failed inflation target, and failing banks. 

** Since July of 2018 and into the new year, the BOJ plan had been to induce 10-year JGB yields to the higher side of its “Quantitative and Qualitative Monetary Easing with Yield Curve Control” band to provide a bit of yield curve steepening and P+L relief to the badly battered small and regional banking sectors (see SGH 4/20/18, “Japan: BOJ Shifts and Abe Pressure”). 

** But with the global economy showing signs of rolling over yet again, or at least some serious deceleration, and the grab for yield in full force again in Europe and now even in the US, those JGB yields dipped right back down to negative 0.045% on February 20, close to the lows this year of negative 0.050% reached in the beginning of January.

** As to that global carry trade, it is now being reported in the domestic media that Japanese banks, especially local banks, are rushing to invest in US dollar denominated risky assets, including junk bonds and CLOs (collateralized loan obligations), taking those greater risks to obtain higher returns, pushed out by the zero-interest rate environment in yen denominated fixed-income instruments. 

** And that has attracted the notice of the FSA (Financial Services Agency) regulators. To better control that risk, the FSA is said to be planning to introduce new regulations in March of this year that will place limits on investments in CLO and other types of securitized debts by Japanese banks, implying with it a strong degree of precaution over the financial health of these banks as well.

** But most significant of all, it is perhaps with all this in mind that Koichi Hamada, the always interesting and influential adviser to Prime Minister Abe, last night started the process of re-branding the Kuroda-era BOJ’s 2% inflation target as simply a means to an end – full employment – and not the driving force for monetary policy going ahead. 

** That is a spin with significant policy implications, and one that should not be taken lightly. Even Kikuo Iwata, the former Deputy Governor of the BOJ, himself at the vanguard of ultra-dovish policy, has now weighed in pessimistically on the impact of the central bank’s present ultra-loose monetary policy. In an interview on February 18, Iwata lamented that “the BOJ’s current policy does not have a mechanism to heighten inflation expectations.” 

Perhaps he has forgotten who asserted that the BOJ is solely responsible for achieving a 2 percent inflation, and that deflation is simply a monetary phenomenon to be solved.

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