Time is ticking for BOJ to change policies before the yen implodes

With rise in US inflation measures in May once again exceeding expectations, hopes for a less hawkish Fed have been severely dashed, especially as core inflation gauge there is pointing to growing entrenchment of higher prices. This takes us immediately to our own market in Japan where BOJ’s ongoing policy errors which we have underlined since mid-February, ever since the central bank upped its JGB purchases to suppress long term rates, have led to a severe devaluation of the yen, leading to rising imported input costs and falling real wages. 

As we also noted in this publication in early May, dangers are growing that this trend could lead to an Asian currency contagion. This is now becoming better understood and is starting to alarm capital markets. Indeed, Japan’s central bank not only looks blatantly out of touch with global pricing trends by labelling higher inflationary forces appearing onto its shores as “transitory” but as we have outlined more recently, its expectations that Japan’s CPI should hover around 2% for the foreseeable future as looking miles offside judging by the announced price hikes we are seeing across the industry. 

We see Japan’s inflation gauge spiking much further and would not be surprised to see it approaching 5% level in the second half of this year. BOJ governor, Mr. Kuroda’s recent comments that higher price trends are starting to be accepted by Japanese consumers came under heavy criticism by the general public and some law makers, forcing a rare apology that in our view is pointing to a growing intolerance of his failed economic policies that date back to Abenomics days. 

Although talks that Japan’s Ministry of Finance could stage an intervention in the currency market to stabilise the yen is getting louder, we find such a move to try offset the effects of BOJ’s own interventions in the JGB market to suppress long-term rates as being nothing short of comical. This would practically mean one of Japan’s economic policy bodies fighting market forces to try to offset the negative impact of those of another. Ultimately, we think neither would succeed and BOJ will be forced to drop its yield controls and allow longer term rates to head higher. 

We think the prospect of this major policy shift is not far away now as we sense that policy makers are starting to panic as indicated by talks of currency interventions as the weak yen is further constraining household budgets. This policy change should not only help strengthen the Japanese unit which looks grossly undervalued but it should bring with it a big pay day for those macro funds short of longer dated JGBs. It should also provide a notable rerating trigger for Japanese banks and insurance stocks which are already out-performing Topix in anticipation of this.