Grant's Almost Daily Interest Rate Observer

Is the Japanese Yen looking at a sharp decline?

If a bond yields nothing and no one trades it, does it even exist?  That existential question is put into relief by a dispatch from Bloomberg this morning: Not one solitary lot of the Japanese 10-year note changed hands during Tuesday’s trading session (the market was open – we checked). Bloomberg notes that “Barclays Securities Japan rates strategist Naoya Oshikubo, summed it up, with perhaps an understatement: ‘the JGB [Japanese Government Bond] market was generally thin.’”  Indeed.  For context, the active (June) contract of 10-year U.S. Treasury futures saw trading volume of just under 1.7 million contracts yesterday, equating to a dollar value of $202 billion. 

 

Of course, one needn’t look too far to the explanation for a dormant debt market in the world’s third largest economy.  The Bank of Japan (BoJ) has been hard at work at its “Quantitative and Qualitative Monetary Easing” strategy since April 2013, while “Yield Curve Control” has been monetary dogma since September 2016.  A zero-percent 10-year yield is part and parcel with that policy, and the BoJ is taking every measure to ensure that no pesky investors get in the way of its objectives. Bloomberg writes in the same story that “Governor Haruhiko Kuroda noted to lawmakers Wednesday that the central bank has bought 75 percent of the government bonds issued in the fiscal year ending this March.” 

 

The JGB market’s long road to zero yields has been colored by more than BoJ monetary policy or even the worldwide bond bull market. Following the bursting of a spectacular stocks and real estate bubble of the 1980’s, the Japanese economy has been marked by stagnation: Since 1998, Japanese year-on-year CPI growth has averaged 0.1%. In that same 20-year period, Japanese year-over-year real chained GDP growth has averaged just 0.8%. 

 

In an effort to reach the consensus monetary Valhalla of 2% inflation, the BoJ has undertaken policy that leaves its peers in Europe and the United States in the dust: In the five years ended Feb. 28, Japan’s monetary base (comprised of money in circulation as well as bank reserves) has increased by 281% to ¥475 trillion ($4.4 trillion), or just under 31% annualized growth. By comparison, the European Central Bank has increased its monetary base by 63% over the past five years (10% annualized growth), while the Federal Reserve has overseen a 34% uptick in the U.S. monetary base, or 6% annualized.  On the consumer inflation count, the BoJ has been somewhat successful.  Over the past five years, average CPI growth has risen to 0.9%. 

 

While the BoJ prints yen, the Fed is nearly six months in to its (very gradual, to be sure) balance sheet reduction while the 10-year Treasury yield has more than doubled from its July 2016 lows of 1.37%. The Wall Street Journal noted on Feb. 28  that foreign investor demand for Treasurys has been crimped by rising hedging costs as the Fed continues to raise overnight interest rates (Almost Daily Grant’s, Feb. 28). Nevertheless, Russell Napier, independent strategist and co-founder of the Electronic Research Interchange, speculates in to day’s “The Solid Ground” commentary on potential consequences if Mr. and Mrs. Watanabe come to find U.S. Treasurys and their positive real yields too tempting to resist:

 

Might this additional relative yield tempt Japanese investors? If it does, who buys the JGBs they most likely liquidate to fund their Treasury purchases? If such a liquidation is triggered, the BOJ balance sheet expansion, given their yield target for JGBs, would accelerate just as the Fed’s balance sheet contracts.

 

So, the more the Fed acts to contract its balance sheet, the more it could, through enticing Japanese savers to the Treasury market, force an accelerated balance sheet expansion on the BoJ. This [effort], aimed at driving up all asset prices, while maintaining relative interest rate stability, will very clearly be over. The impacts from a decline of the yen on the international exchanges will be profound. 

 

The yen currently trades at 106.8 per dollar, almost exactly at its 20-year average. 

 

For its part, the central bank has evinced no lack of conviction in its goal or its methods. The BoJ website explains that “When prices fluctuate, individuals and firms find it hard to make appropriate consumption and investment decisions, and this can hinder the efficient allocation of resources in the economy.”  Potential consequences of unrivaled financial repression were left unmentioned.