What does Japan tweaking rates means for global markets? Bill Blain, market strategist, Shard Capital takes a view.
Japan says it is not tightening. The Bank of Japan (BoJ) “eased” yield curve control which is normalisation by any other name. It will have profound global investment flow consequences.
Kazuo Ueda, Governor of the BoJ gave a masterclass in central bank obfuscation while not explaining very much as he dodged the tightening vs easing question – saying it was about flexibility. Strip out the noise and it’s a key step in the long slow path to Japanese financial and monetary normalisation.
The reality is the BoJ presented a “tweak” to its long-standing Yield Curve Control (YCC) policy by announcing it would allow JGBs (Japan Government Bonds) to trade at higher yields – effectively 1% vs 0.5% last week. Forget the BoJ saying its “not yet ready to tighten monetary policy” Japan is normalising – and that is a critical opportunity.
Why are the BoJ being subterfuge about what they are doing? Well, they couldn’t really admit that their tightening rates to address inflation – that would undermine the consensus and the current moves underway to reform and rejuvenate Japanese corporate behaviours and bounce up the stock market.
So why does it matter that the BoJ is normalising? In essence, Japanese bond rates have effectively been zero for three decades. The BoJ owns 52% of the JGB market – over $4 trillion in dollar terms. As a sidenote, raising rates by 50 basis points, (effectively doubling them), means the BoJ is going to post a spectacular unrealised loss when it announces results in September.
However, the bottom line is that Japan is becoming a relevant investment destination again.
Ultra-low returns, and a stock market left comatose by the excesses of the 1980s, means that for the last 30 years, and particularly since 2012, Japanese investors have pumped trillions of dollars into foreign markets – nearly $3 trillion in last 10-years. Effectively, it’s the last major Western nation where QE monetary distortion is still fuelling speculative stock and bond prices.
The QE monetary distortion era ran from 2010-2021 – designed to boost investment post the Global Financial Crisis. During that time, it is estimated that QE purchases by the leading Western Economies pumped some $21 trillion of new money into markets which almost entirely went into global financial assets rather than financing real assets. It created the most monetary market distortion of all time, which many market participants still don’t understand or acknowledge.
Incidentally, the reason global central banks printing $21bn of QE did little to drive inflation is because it all went into financial asset inflation, leaving lots of investors thinking they were investment geniuses because they bought stocks that went up – but only because of financial asset inflation.
Japan accounted for about $5 trillion of global QE with 60% of that invested overseas in search of returns. Pulling $3 trillion from stock and bond markets is bound to have an effect. Although it will take time, one of the few things I can guarantee is that when money gets more expensive – speculators become more careful. Japan investors hold over $1 trillion of Uncle Sam IOUs (Treasury Bonds). As Japan starts to strengthen – Japanese stocks looking greater value as the economy ticks up and new policies persuade corporates to create shareholder value- suddenly the whole market is waking up to just how cheap Japan looks.
As the dollar starts to tumble on relative rates, normalisation will push the yen higher. The carry-trade of borrowing yen at 0% to invest in US treasuries at 5% takes a tumble if the yen strengthens from 140 to 80 again (as it was just 10-years ago.)
Japan’s economy has its problems – not least demographics – but its effect could be on the edge of an innovation surge. Consider Toyota. I’m told their new battery tech will overturn the current electric vehicle paradigm with new light weight BEVs with fast charging long-range energy dense solid-state tech that will leave Tesla looking like a brontosaurus.
Toyota is not the only Japanese corporate that’s been quietly getting on with the business of better business over the last decade. The bottom line is that new money is likely to flow from US and European financial assets into what will look like cheap Japanese markets – and not just Japanese money being repatriated – but new foreign investment. In terms of the balance, it means money that would have been frothing US markets is now going elsewhere.
