July 28, 2016, 4:00pm EST
As we’ve discussed, the big event of the week is the Bank of Japan decision on monetary policy tonight. Today the speculation is that Abe presented his big government spending plan earlier than expected, and bigger than expected, to put pressure on the Bank of Japan to act now, rather than later.
But as we discuss in today’s note, the Bank of Japan is run by a governor hand selected by Abe. It’s fair to think they are on the same page.
Today we want to revisit some of our past analysis on why this event is so meaningful to global markets and the global economy. The stakes are high.
As we know, where the Fed left off on its global economic stimulus, the Bank of Japan has picked up. QE hasn’t had the punch to growth that central bankers initially thought it might, but it has indirectly driven the global economic recovery, by restoring confidence, which has ultimately incentivized people to invest again, hire again, and spend again.
Nobody knows the fragile state of the world like the biggest central banks. They’ve committed trillions of dollars over the past seven years to pull the world from the edge of apocalypse, to manufacture a recovery and to keep it all together along the way. With that, the Fed began reversing its emergency policies only because they knew the torch would be picked up by Europe and Japan. But it’s Japan that has the perfect ingredients to meaningfully change the path of the global economic recovery, and cement its certainty.
Japan, unlike many other major central banks (including the Fed), has all of the right ingredients to achieve its inflation goal via the printing press – it has the biggest debt load in the world (which can be inflated away by yen printing), it has persistent deflation (which can be reversed by printing), and it has decades of economic stagnation (which can be reversed with hyper easy money and improvements in the global economy).
In short, they can do all of the things that other powerful central banks/economies can’t do – and it can result in a huge benefit not just in Japan but for fueling a recovery in the global economy (as capital pours out of Japan). In a world with few antidotes to the structural economic problems, this is a potential solution for everyone. So perhaps the most important ingredient for a successful campaign in Japan – they have the full support/hope/wishes of the major global economic powers (U.S., Europe, U.K.).
The Japanese Prime Minister Abe was elected on the promise of ending the economic malaise and deflationary vortex that’s troubled Japan for more than two decades. And he hand appointed a governor of the Bank of Japan (Kuroda) to execute an all out war on deflation.
The Bank of Japan has promised to run their aggressive QE program at full tilt until they can produce a target of 2% inflation in their economy. But inflation is still dead in Japan. Both Kuroda and Abe have said in the past year that they’ve committed to do whatever it takes, and for as long as it takes. Importantly, a huge part of their success is (and will be) dependent upon higher Japanese stocks, and a weaker yen. They have explicitly said so. It’s part of their gameplan.
With that in mind, Japan surprised markets on January 29 by cutting rates to negative. Prior to that move, we made the case that they needed to act. The market was ripe for it. They did. They surprised many. But they haven’t gotten the desired effect.
Since they cut their deposit rates below zero, the yield on the 10 year Japanese government bond has gone negative. And the 20, 30 and 40 year bond yield has collapsed too — indicating the market doesn’t believe Japan will ever emerge for the deflationary vortex. On that note, the move to negative rates hasn’t worked thus far.
And when it comes to stocks and the yen, they’ve gotten the opposite of what they need and want.
Japanese stocks and the yen have returned back to the 2014 levels, when the BOJ surprised markets with a big second round of QE. So there’s been an undoing of significant policy action.
You can see in the chart below, the BOJ action on October 13, 2014 (“BOJ Surprise QQE2″), and the effect it had on stocks.
Source: Reuters, Billionaire’s Portfolio
Japanese stocks took off and rose 33% over the following eight months. And virtually all global stocks followed, including U.S. stocks. Now it has all reversed for Japanese stocks and the yen.
As we’ve said, before it’s all over, we think the BOJ will ultimately destroy the value of the yen, returning USDJPY to 250+ versus the dollar (last seen in the 1980s). USDJPY goes into the meeting around 105.
We know Bernanke met with the BOJ governor late last month to discuss the concept of “helicopter money” in Japan. So while the expectations have been set for more action, the magnitude of response could easily surprise. A negative surprise, where they do nothing tonight, would almost certainly put Japan in an even more difficult hole to fight out of.
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