Did Japan’s Moves Open Door To A Big Yen Devaluation


September 21, 2016, 4:40pm EST

Yesterday we talked about the two big central bank events in focus today.  Given that the Bank of Japan had an unusual opportunity to decide on policy before the Fed (first at bat this week), I thought the BOJ could steal the show.
Indeed, the BOJ acted.  The Fed stood pat.  But thus far, the market response has been fairly muted – not exactly a show stealing response.  But as we’ve discussed, two key hammers for the BOJ in achieving a turnaround in inflation and the Japanese economy are: 1) a weaker yen, and 2) higher Japanese stocks.

Their latest tweaks should help swing those hammers.

Bernanke wrote a blog post today with his analysis on the moves in Japan.  Given he’s met with/advised the BOJ over the past few months, everyone should be perking up to hear his reaction.

Let’s talk about the moves from the BOJ …

One might think that the easy, winning headline for the BOJ (to influence stocks and the yen) would be an increase in the size of its QE program.  They kicked off in 2013 announcing purchases of 60 for 70 trillion yen ($800 billion) a year.  They upped the ante to 80 trillion yen in October of 2014. On that October announcement, Japanese stocks took off and the yen plunged – two highly desirable outcomes for the BOJ.

But all central bank credibility is in jeopardy at this stage in the global economic recovery.  Going back to the well of bigger asset purchases could be dangerous if the market votes heavily against it by buying yen and selling Japanese stocks.  After all, following three years of big asset purchases, the BOJ has failed to reach its inflation and economic objectives.

They didn’t take that road (the explicit bigger QE headline).  Instead, the BOJ had two big tweaks to its program.  First, they announced that they want to control the 10-year government bond yield.  They want to peg it at zero.

What does this accomplish?  Bernanke says this is effectively QE.  Instead of telling us the size of purchase, they’re telling us the price on which they will either or buy or sell to maintain.  If the market decides to dump JGB’s, the BOJ could end up buying more (maybe a lot more) than their current 80 trillion yen a year. Bernanke also calls the move to peg rates, a stealth monetary financing of government spending (which can be a stealth debt monetization).

Secondly, the BOJ said today that they want to overshoot their 2% inflation target, which Bernanke argues allows them to execute on their plans until inflation is sustainable.

It all looks like a massive devaluation of the yen scenario plays well with these policy moves in Japan, both as a response to these policies, and a complement to these policies (self-reinforcing).  Though the initial response in the currency markets has been a stronger yen.

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