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After ¥120-trillion of BoJ liquidity injections, since Oct ’14 – the US$ is Unchanged vs Yen

May 09, 2016

    Nearly 18-months ago, on the evening of Friday, Oct 31st, 2014   -the Bank of Japan BoJ> shocked the markets, saying it would increase the size of its purchases of government bonds by ¥15 trillion yen ($135-billion) to about ¥80 trillion ($725 billion) in total annually. BoJ chief Haruhiko Kuroda said the increase was required to prevent a reversal into a “deflationary mindset” that the country’s leaders contend has stymied growth for many years. Countering such a trend is “the most important thing we can do,” Kuroda said. “Whatever we can do, we will.”

    In a knee-jerk reaction, the Nikkei-225 stock index jumped +4.8% by the closing bell in Tokyo to close at a seven-year high of 16,413, and the US$ rose 2 percent to ¥110.75 after the unexpected decision, its best level since January 2008, lifting exporters. Toyota Motor Corp <7203.T> jumped 3.8 percent, Honda Motor <7267.T> surged 4.7 percent and Tokyo Electron Ltd <8035.T> soared 3.8 percent. Financial shares also surged, with Mitsubishi UFJ Financial Group <8306.T> rising 4.0 percent, Sumitomo Mitsui Financial Group <8316.T> soaring 7.2 percent, and Nomura Holdings <8604.T> surging 6.8 percent.

    At the same moment, the Federal Reserve was ending its own radical scheme of bond purchases, known as quantitative easing, <QE> which it instituted after the global recession to help the U.S. stock markets recover. After three rounds of QE, the Fed had pumped $3.7-trillion of fresh US$ liquidity into the global markets. The market also got a boost from news that Tokyo approved targets for the $1.2 trillion Government Pension Investment Fund (GPIF) which aim to increase the ratio of Japanese shares in its holdings to 25% form the previous 12%.

    As such, Tokyo was determined to drive the yen’s exchange rate lower by flooding the markets with freshly printed yen. The BoJ had already owned 20% of Japan’s $11-trillion bond market, and the scale of its buying suggested the BoJ could end up owning half of the JGB market by as early as in 2018.

    However, six-months later, the US$ had clearly lost its upside momentum after reaching a 13-year high near ¥125.  On June 10th, 2015 – BoJ chief Kuroda was proclaiming victory over the “deflation mindset,’ adding the Japanese “economy is on the right track”, and “QQE is working.” The US$ had risen to ¥125.86 – its highest since June 2002. Mr Kuroda said there is “no doubt” that QQE — quantitative and qualitative easing — was having its desired effect. “The policy effects of QQE are such that they are roughly equivalent to those that would arise from making almost ten -0.25% rate cuts in one shot under conventional monetary policy.”

    However, reacting to political pressure from neighboring China, South Korea, and the US, – Tokyo sought to put a lid on the US$’s advance. Speaking to Japanese lawmakers on June 10th, 2015 , Kuroda sent a signal to currency traders, saying the US$ was not bound to rise against the yen, even if the Federal Reserve raises interest rates because FX traders may have already priced into the market the possibility of a series of Fed rate hikes. “If you look at the real effective exchange rate, it shows that the yen is already very weak,” Kuroda said. “Even further declines on a real effective exchange rate basis are not likely to happen.”

    Mindful of the BoJ’s $1.25-trillion stash of foreign currency reserves, mostly parked in US$’s, Kuroda’s jawboning effectively halted the US$’s spectacular rise at ¥125.86 – its highest since-June 2002, a 13-year high. Kuroda added; “It’s hard to conclude decisively that the dollar will  continue to strengthen further just because the Fed has done tapering and eyeing raising interest rates,” Kuroda told lawmakers in parliament. Instead, Kuroda said it is desirable for the yen to trade in a range that broadly reflects economic fundamentals. And for the next six months, the US$ behaved nicely, gyrating within a narrow range between 118-yen and 122-yen, much to the satisfaction of Tokyo’s financial warlords.

    However, on January 28, 2016 – Tokyo’s financial warlords shocked the world markets again, – BoJ chief Kuroda unexpectedly adopted negative interest rates, risking another round of competitive devaluations. The currency fell against all 16 of its major peers after Japan’s central bank voted 5-4 to apply an interest rate of minus -10% to current accounts held at the central bank, and sent shock waves through currency markets. The move raises the specter of further easing by other central banks in the Euro zone, Switzerland and Sweden that had already lowered their deposit rates below zero.

    In a knee-jerk reaction, the US$ jumped +2% to ¥121.18 and the Euro rose +1% to ¥131.31. Signs of a renewed recession in Japan and advice against the bank’s ability to expand its already sizable asset-buying program amid liquidity concerns are also seen contributing to the move.  Central banks use their deposit to influence how banks handle their reserves. In the case of negative rates, central banks want to dissuade lenders from parking cash with them. The hope is that they will use that money to lend to individuals and businesses, which in turn will spend the money and boost the economy and contribute to inflation. It is also aiming to force investors to shift money out of bank accounts and into higher-yielding assets.

    However, two weeks later, on Fri Feb 12th, 2016; it had become apparent that the BoJ’s shift to negative interest rates had backfired.  Japan’s Nikkei share average fell more than -5% to a fresh 16-month low , and was set for its biggest weekly drop since 2008 as investors rushed to dump risky assets after the dollar dived to a 15-month low against the yen. The Nikkei-225 index fell as much as -5.4% to 14,865 in morning trade, a level unseen since October, 2014. For the week, the Nikkei has fallen -12%, heading for the biggest weekly drop since October, 2008.

   The US$ fell as low as ¥111, its lowest level since October 2014 – when the BoJ first boosted its QQE scheme to ¥6.5-trillion /month. Traders said that investors feared Japanese exporters hopes of earnings growth will suffer if the yen strengthens further. Automakers were hammered, with Toyota Motor Corp (7203.T) falling -6.5%, Honda Motor Co (7267.T) dropping 4.8 percent. According to analysts at Nomura Securities, when the dollar falls by 1-yen, it cuts Japan Inc’s pretax earnings by -0.4-0.5% and pushes down the Nikkei share average by 400 yen.

    By April 7th, 2016- Senior government officials were  escalating warnings to speculators against pushing up the yen too much, stressing their readiness to take “appropriate action” in the market against what they see as one-sided moves. The dollar hit a fresh 17-month low of 107.70- yen. But the jawboning has failed to stop market participants
from testing policymakers’ resolve with many betting Tokyo will not intervene unless the dollar falls below 105 yen.

   A Group of 20 agreement in Shanghai signed in February prohibited countries from competitive currency devaluations, which makes it difficult for Japan to intervene. Japanese financial bureaucrats dismiss such a view, pointing to other parts of the G-20 communique that reserve Tokyo’s right to intervene if the yen rises too sharply, namely a part that warns against “excessive volatility”   Yet after nearly ¥120-trillion of liquidity injections, since Oct 31st, 2014, under Japan’s hyped QQE scheme- the US$ is trading at the same levels that prevailed 18-months ago. Roughly $5.1-trillion of Japanese government debt is yielding less than Zero percent, yet the US$ continues to remain weak against the yen, confounding analysts and traders alike. 

   Mr Kuroda argued QQE would be instrumental in generating “a virtuous cycle” in income and spending for both corporations and households, leading to a “significant turnaround” in the economy.  However, nearly one year later- Japan’s exports had fallen for a sixth straight month in March as slowing growth in China, soft demand for electronic components for products such as the iPhone and a strengthening yen had pushed Japan’s economy back into a recession. Despite the zigzags in growth last year, Japan’s economy eked out a paltry +0.4% expansion in 2015, after flat-lining of 2014. But that pace of growth falls far short of the expansion needed to achieve Abe’s goal of a 600 trillion yen ($5.3 trillion) economy by 2020.  The Ministry of Finance said Japan’s exports fell -6.8% in the year to March.  Exports to Asia, which accounts for more than half of Japan’s shipments, fell -9.7%, portending a second straight quarter of economic contraction, and a return to recession in Q’1 of 2016. 

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