BOJ’s policy error to further devalue yen, forcing Kuroda regime change

In our February 12th publication, just before the war in Europe led us to readjust our expectations for global growth, we dedicated that weekly to potentially dire implications of BOJ’s emergency JGB purchasing plan announced a few days earlier. BOJ had clearly signalled that it will not tolerate long term rates from rising any further and warned that its operations will be limitless in volume. 

We argued that one obvious consequence was that the yen was likely to weaken more against the dollar while putting much pressure on Kishida’s government ahead of the Upper House elections in July. Even then household costs were already soaring and higher import bills were eating into incomes. 

We also pondered whether BOJ’s more aggressive QE will be viewed as a big shorting opportunity in longer dated JGBs for macro funds. These funds would likely sense that BOJ cannot keep long term rates suppressed for too long and diverge monetary policy path from central banks of other developed nations which have mostly been dropping yield controls, tapering or discontinuing QE, and generally preparing for a tighter monetary policy phase. For them, inflation has clearly become a long term threat, especially as the end of pandemic will bring its own stimulus as we are already seeing with surging air ticket prices and and equally strong bookings.  

Interestingly, in Japan with year-on-year impact of lower mobile phone charges looking to drop off from this April, the inflation gauge is likely to rise towards 2% level long targeted by the central bank. However, its chief, Mr Kuroda is now suggesting that this is bad inflation and as long as good inflation doesn’t come along, he will pursue the same super lax policies that have done much damage to Japan’s financial institutions, hurt domestic demand, pressured real wages down and made the country more dependant on its exports. 

We think these continued policy errors by BOJ will now become amplified as the yen weakness becomes more pronounced and problematic. Kuroda has argued that the yen’s most recent drop against the dollar, having fallen to its six-year lows, is more a function of dollar’s strength given the geopolitical backdrop that has left the greenback acting more as a safe haven.

However, the yen has historically also been a good safe haven asset, especially during such current times of elevated uncertainties. Theoretically, the yen should have at least held to its early gains against the Euro after the war broke out given Europe’s big Russia and Ukraine exposure. However, the Japanese unit has given back all its gains and it is testing its early February lows. This strongly suggests to us there is an undercurrent of yen weakness also at play here that is gathering more momentum.

Indeed, officials from Japan’s Ministry of Finance which oversee forex movements are already sounding very concerned about this rapid depreciation of the Japanese currency. With the yen likely to continue to trend weaker in the short term as Kuroda’s reckless comments is only encouraging more selling of the unit, we think political pressures will begin to mount on BOJ to abandon its policies and allow yields to rise.

But to get there we need the yen falling to levels where MOF becomes more vocal, even warning of a potential intervention. That to us would signal a major conflict among Japan’s two economic policy making bodies and an imminent BOJ regime change which should prove bullish for the yen, not to mention, Japanese financial stocks.