The current financial markets, in which everything revolves around central banks and the global currency war, has entered a new phase.
It’s more complex – and perhaps more dangerous.
The actions taken by central bankers are no longer having their intended effects on the markets. In fact, the results within the market are often the exact opposite of what bankers had anticipated.
BOJ Shooting Blanks
Take a closer look at the Bank of Japan.
While the Japanese yen was expected to sharply decline even as the banks plunged into negative interest rates, the move was meant to create an opportunity for the country. After all, a weak yen would help corporate Japan remain a competitive exporting power.
Logic – including negative interest rates, a country heavily in debt, and a lousy economy – dictates that the yen take a plunge. But instead, the value of the yen is soaring ahead.
Due to this unforeseen outcome, all of the BOJ’s advances since it’s become more aggressive in its monetary policy in October of 2014 – have now been unwound.
The Japanese yen is up 15% as opposed to the dollar since the middle of last year. And with every blip that the yen rises in value, Japanese stocks continue their downward tumble, with the Nikkei 225 index falling 8% or so in just the past seven trading days.
How Did this Happen?
One likely cause is the Fed’s Janet Yellen continuing to weaken the dollar.
It’s been a three-way shootout between the Fed, the Bank of Japan and the European Central Bank in this currency race to the bottom, with each group taking a shot at the others.
The Fed fired the first shot with the launch of Quantitative Easing (QE). Then the Japanese and Europeans countered with, at first, even lower rates. Then they threw in negative interest rates. Now, Yellen has fired back with the halt of this year’s planned interest rate increases.
Another reason for this unpredicted spike in yen valuation is a partial unwinding of the Japanese carry trade.
This plunge into negative rates by Japan scared some big investors. These investors had borrowed in yen at basically zero rates to invest in stocks across the globe. When investors become fearful, they sell stocks and pay back the loans to avoid losing their money. In effect, they’re buying yen and pushing up the price.
Japan Will Have to Act
It’s hard to imagine how Japan will weasel its way out from between a rock and a hard place – namely, the Federal Reserve and the European Central Bank.
Even though American politicians will rail against Japan, only continuing to manipulate their currency, the Japanese, surely, won’t stand idly by as the strong yen goes on a Godzilla-style rampage through their economy.
I anticipate that action will be taken as soon as the yen reaches the 105 level as opposed to the dollar. Currently, it’s around 108.
Even if it has to act unilaterally, the Bank of Japan may have to begin selling yen in the currency market, in an attempt to finally weaken its value.
The goal of the next shot in this currency war would be, at the very least, to get the yen back into the 110-115 range. Most Japanese companies are comfortable with the yen closer to 120 and would be able to conduct business as usual in a more stable state.
With the next BOJ meeting scheduled for April 28, we won’t have to wait long for a plan to be revealed.
What Lies Ahead
Due to the backfiring of Japan’s negative rates, I expect the Bank of Japan to attempt a different approach in self-defense.
There are, actually, a couple of intriguing possibilities.
One such option lies within Japanese stocks: If the BOJ were to buy shares in their own country’s corporations, this would directly prop up the market. The BOJ already purchases ETFs and could expand their role in the trade.
Another possibility would be stepping up their purchases of European and U.S. bonds directly, offering incentives to Japanese financial institutions to buy more of these bonds.
Already, Japanese institutions have increased buying foreign bonds. This activity level is at its highest since April 2008. But, lots of the buying has been concentrated in Australia, driving the Aussie dollar up, and leaving the rest of the world with little resulting change.
If the Japanese instead begin buying an influx of U.S. Treasuries, there would be a subsequent selling of yen to lower its value. This would also lower U.S. long rates, firing another blow directly to Yellen’s Fed plan.
It wouldn’t be shocking to learn that the BOJ head has breached discussion on the subject of “helicopter money” either – a tactic in which a country’s central bank gives money directly to its citizens rather than going through traditional banking channels.
I fully expect that Japan, with its long-moribund economy, will eventually be the first economy to try this controversial tactic.
Stay tuned. The fight is about to get a lot more interesting.