Hints BoJ may be planning more negative NIRP
JPY has led the recent rebound in the USD since the Jackson Hole Symposium and apart from speculation over a possible rate hike by the Fed, the outlook for BoJ policy is also generating renewed focus. BoJ’s Kuroda has argued he has further scope to ease policy and mounted a defense on the effectiveness of his NIRP and QE policies at Jackson Hole. We have argued several times this year that the strength of the JPY has been a key element driving broader market trends towards a weaker USD and a global scramble for yield. Furthermore, it is perhaps the most important factor undermining the effectiveness of BoJ monetary policy. A Japanese government advisor on Monday made the same points and passionately called on the MoF to step into the game and use FX intervention policy to support BoJ policy measures. Fed’s Fischer hinted that the BoJ may reinvigorate its commitment to NIRP, and Kuroda made it clear that there is still significant scope to lower rates further. We can see scope for the BoJ with tacit support from the MoF to finally turn the tide for the JPY this year.
JPY a key influence on global market trends
We have argued in the past that the strong JPY, despite the BoJ’s Negative Interest Rate Policy (NIRP), has contributed to a range of global market developments.
NIRP/QE drove down yields, and as the JPY rallied it contributed to lower Japanese inflation expectations, further pushing down Japanese yields to remarkably and irrationally low levels.
The fall in Japanese yields spilled over to global bond markets and was a key contributor to a global scramble for yield. Persistent delays in US Fed policy hikes, further QE policy easing by the ECB and, more recently, a rate cut and QE by the BoE have also contributed to low global bond yields, forcing investors to scramble for diminishing yields in higher risk assets, including emerging market and commodity currencies.
The scramble for yield and strong JPY distracted the market from a modest improvement in the USD yield advantage for much of the year. Most of this improvement in the USD yield advantage came from lower yields abroad, rather than higher US yields. Nevertheless, the USD has significantly under-performed this improvement in its yield advantage.
As the market scrambled for higher yielding assets, it turned to the USD to fund these investments (i.e. selling the USD and/or borrowing USD to buy higher yielding assets and currencies). This tended to weaken the USD, even though its yield advantage improved moderately and the cost of borrowing USD increased.
The rising and volatile JPY discouraged investors from using it as a funding currency, and the rising JPY itself tended to spillover to broader USD weakness. As such, the market came to see the USD as a relatively weak currency this year, further encouraging investors to use the USD as the preferred funding currency.
Complacency over Fed hikes
This preferred funding currency status of the USD has probably also contributed to a sense of complacency over the risk of Fed rate hikes. The market has been more willing to believe that rate rises in the US may be persistently delayed.
On two occasions this year, the Fed has warned that a hike in coming months is likely. This was the case in May this year, until the hike plans were scuttled by the release of a sudden drop in payrolls growth in the May employment report, along with a sizeable downward revision to April.
In recent weeks, after payrolls have been strong in the last two months, the Fed has again put a hike on the table. However, this time it is emphasizing data dependence, putting the onus on at least the next employment report for August, due on Friday, to make the case for a hike as soon as the next policy meeting on 21 September.
The USD firmed in May and has again in recent weeks on the possibility of an imminent rate hike by the Fed.
It remains to be seen if the labor data on Friday will be strong enough to push the Fed towards its second hike this cycle. We are not convinced it will, in which case we might see the USD fall back again on resurgent demand for higher yielding assets and currencies.
Gradual and Cautious Fed
A theme of Fed policy comments over recent months has been that, while they may be approaching the second rate hike this cycle, the long run neutral policy rate has been revised down and current rate settings are only modestly accommodative. As such, the Fed is likely to raise rates very slowly and may not have far overall to hike rates in the current cycle. As such, it is quite possible for the market to resume its demand for somewhat higher yielding EM and commodity currencies once focus shifts from the September policy meeting.
However, there are a couple of other elements that are coming into play.
Kuroda may be preparing deeper NIRP
Since Jackson Hole, the JPY has fallen relatively sharply after rejecting the 100 level in USD/JPY that it had been butting up against for a number of weeks.
As discussed above, the strong JPY has been a significant cause of the scramble for yield and, until recent weeks, the weak USD trend. We may be at a key turning point for the JPY, which could reverse some of the broad weakness in the USD this year and see it reconnect to its yield advantage, even if the Fed continue to move hesitantly along its rate tightening path.
We are reluctant to call a bottom in the USD/JPY; we have been wrong on this before this year and it retains a strong rising trend overall.
The 29 July BoJ policy meeting was a massive let-down for the market that was waiting for the BoJ to further expand its QE policy and dove-tail with an announcement by the government that it planned fiscal expansion.
However, the BoJ only tweaked policy and announced a comprehensive review of its monetary policy. In response, Japanese yields and the JPY rose on speculation that the BoJ may back-down from its aggressive policy easing.
The potential disruption to global yields was offset by a surprising announcement by the Bank of England in early August to resume its QE and cut rates. This combined with the stronger JPY to sustained the scramble for yield and broadly further weaken the USD.
The USD/JPY has led the rebound in the USD since the Jackson Hole Symposium last Friday. This may reflect renewed hope that the BoJ may renew its commitment to monetary policy easing. Recent comments from Kuroda suggest that there is no planned retreat and in fact he is prepared to ease further across all dimensions including lowering cash rates further and expanding asset purchases.
At the Jackson Hole Symposium he said, “Looking ahead, the Bank will continue to carefully examine risks to economic activity and prices at each monetary policy meeting and take additional easing measures without hesitation in terms of three dimensions — quantity, quality, and the interest rate — if it is judged necessary for achieving the price stability target. QQE with a Negative Interest Rate is an extremely powerful policy scheme and there is no doubt that ample space for additional easing in each of these three dimensions is available to the Bank. The Bank will carefully consider how to make the best use of the policy scheme in order to achieve the price stability target of 2 percent, and will act decisively as we move on.”
In particular, it appears that the BoJ is leaning towards a deeper lowering in its NIRP. Kuroda mounted a defense of this policy at the Jackson Hole Symposium, despite considerable criticism of its effectiveness. He said, the current -0.10% cash rate “is still far from such a lower bound” and described NIRP “as a practical monetary policy tool.”
It is fair to say that the BoJ has limited scope to further expand QE policy in consideration that the BoJ already owns over a third of outstanding government bonds, and the distortion that this may be contributing to in the market. Although there have been press reports suggesting that the BoJ may expand purchases to local authority (zaito) and local government bonds.
Furthermore, Federal Reserve Vice Chair Fischer may have hinted subtly and inadvertently on Tuesday that the BoJ was leaning this way. He said, those central banks that are using NIRP, “basically think they are quite successful and are staying with that approach, possibly with the exception of Japan. They are thinking it through and said they will come back to try and make negative rates work better.”
So the BoJ are thinking it through and may try and make negative rates work better. This could mean a lot of things (Fischer has been dangling a few loaded remarks out there lately, including on the Fed rates outlook).
Rethinking NIRP may include better managing the JPY outcome
A key failure with the NIRP in Japan as we see it has been the perverse gains in JPY since it was introduced. This contributed to the flattening in the Japanese yield curve, by undermining confidence in the effectiveness of BoJ policy and weakening inflation expectations, pushing down long term yields even more than cash rates.
However, this strong JPY reaction to NIRP in January was perverse, and we have every reason to believe that if the BoJ were to now double-down and cut NIRP further into negative territory, next time it might cause the JPY to weaken.
The JPY rallied after NIRP in January for a variety of reasons that the BoJ and Japanese government could manage more effectively.
The main question is if Japanese policymakers understand that they really need to make sure that the JPY does weaken if NIRP is pushed harder. This may require a more genuine threat of FX intervention, something that has been conspicuously lacking since NIRP was introduced in January.
Our views on the JPY were expressed forcefully by Koichi Hamada, Special Economic Adviser to Japanese Prime Minister Shinzo Abe in an online post on Monday. He argued that, “Japan’s current travails, which have brought a concomitant decline in Japan’s stock market, stem from the yen’s appreciation – 24% over the last year – against major currencies. “Abenomics” – which included substantial monetary and fiscal expansion – has nothing to do with it.”
A point we have made in the past is that Helicopter money policy, much discussed in the market, should not be considered until the perverse gains in JPY are addressed. Hamada said, “Many hedge-fund managers, along with some economists, claim that the key to saving Japan’s economy from deflation is a more direct helicopter drop, with newly printed cash delivered directly to consumers. Yet these same people are impeding effective macroeconomic policy, by betting on the yen’s appreciation. Only when the speculators are brought to heel should such a bold – and highly risky – monetary policy even be up for discussion.”
Hamada notes that the MoF have warned of intervention in the last month, but the market has not taken them seriously. He highlights the intense pressure placed on Japan to not intervene by the USA, and associated political desire in Japan to pass the Trans-Pacific Partnership (TPP) trade legislation.
He said, “At this point, the MOF’s words will not be enough to deter speculation. But the MOF remains hesitant to back its tough talk with action, not least because of American disapproval of supposed “currency manipulation.” High-level officials at the US Treasury and Federal Reserve actively try to dissuade advocacy of direct intervention, including by me. An American scholar reacted angrily when I merely mentioned the word, as if it were an obscenity. American officials, for their part, emphasize that if Japan can be accused of manipulating currency markets, the US Congress will not approve the Trans-Pacific Partnership (TPP).”
“It is possible that the MOF will choose to keep the US on its side, and continue to offer only empty threats to speculators. Or it may simply vacillate until it is too late to take real action. Either approach may well produce the same disastrous result: allowing the yen to appreciate to damaging levels and causing Abenomics to fail.”
However, he argues that the gains in the JPY justify intervention on domestic policy grounds. “In a flexible exchange-rate system, each country conducts monetary policy independently, based on domestic objectives, and accepts the resulting exchange rate. But when exchange-rate movements become sharp or erratic, monetary authorities have the authority – even the obligation – to intervene to smooth them out.”
He said, “What the MOF should do is intervene courageously in currency markets to stem the yen’s appreciation. Speculators will learn a tough lesson, and Japan’s economy could get back on track. Though Japan may become a scapegoat for the failure of the TPP, it seems unlikely that the deal would be ratified in any case, given the current political climate in the United States. An alternative would be for the BOJ to purchase foreign securities.”
Japan vs. the Currency Speculators, KOICHI HAMADA – www.project-syndicate.org
It is unclear what if any influence his views have on policymakers in Japan. But they may indicate something of a mood shift in Japan on the exchange rate. Monetary Policy in Japan cannot work if the JPY continues to strengthen. It is a pretty straightforward axiom that easier monetary policy goes hand-in-hand with a weaker exchange rate.
Japan is arguably experiencing the biggest dis-inflation problem, its policy easing should have a very long way to run. Therefore a persistently strong JPY is incongruous with this and something the policymakers in Japan need to address if they have any hope of achieving their inflation target goals.
The BoJ has been quiet about the influence of the stronger JPY in damaging its monetary policy effectiveness this year. It is clear that this is a politically sensitive topic. Kuroda did not mention it in his speech at Jackson Hole. We hope that if the BoJ do further lower the NIRP on 21 September it has some tacit support from the MoF that it will send a message to the market that it is more prepared to intervene to prevent rapid and sustained further gains in the JPY.
As for BoJ purchasing foreign bonds. We think this would be a good policy, but is highly unlikely since it would be seen as overtly aiming to weaken the currency and direct interference in other countries’ monetary policy.
Unclear what BoJ thinks on QE
It appears that the BoJ may be moving in the direction of lowering the cash rate. It is unclear what they may do with QE. It is possible they adjust the pace of purchases to calibrate them with some overall yield level target. This may help steepen the curve, especially if the JPY were to weaken.
But the key has to be the level of perceived real long term yields. Ideally the BoJ would like to see a steeper yield curve resulting from higher inflation expectations, not higher real yields.
Ultimately the purpose of QE asset purchases is to lower real yields to encourage more investment. The actual volume of QE may be less relevant than the overall level of yields. As such, I do not think it follows that a recalibration of JGB purchases is necessarily bullish for the JPY. I do not see it counteracting the possible negative reaction the JPY should have to a further lowering of the cash rate target.
In His Jackson Hole speech, Kuroda’s also noted that Japanese long term bond yields fell much more than cash rates, after he implemented NIRP combined with QE. And, furthermore, this reaction was much greater than that experienced in Europe in response to the ECBs NIRP/QE policy. Although cautious to not say too much, one might conclude from his remarks that he might prefer a steeper yield curve. A steeper yield curve might be seen as less negative for Japanese bank profitability and Japanese stocks.
A turn in JPY may have broader implications
A turn to a consistently weaker JPY may have significant global market implications. For one it may reverse some of the broad weakening influence in the USD we have seen this year.
It may contribute to some upward pressure on global bond yields, but this may be counteracted by a lower NIRP preventing a big overall rise in Japanese or global yields.
It may reduce some of the scramble for yield driving funds into EM and commodity currencies, especially if the USD more broadly appears stronger and reconnects to some extend with the higher US yield advantage this year. However, it may also revert attention from funding high yield investment from selling USD towards selling JPY.
The performance of the EM and commodity currencies may also depend on the evolving outlook for US rates which are back to being data dependent.