Yen’s implosion will likely force BOJ to pivot

BOJ’s continued inaction followed by dovish statements in support of its ultra-loose policy have left currency traders increasingly confident in shorting the yen. We view the central bank’s policy errors not only needlessly destroying yen’s precious safe haven status but we strongly believe that Japan’s inflation backdrop urgently needs a policy regime change.

We also fear that continued plunge in the value of the Japanese unit could create a contagion that will force a devaluation round of other Asian units that could spill over to all EMs. We are not sure if Japan policy makers fully understand the global implications that this major currency devaluation is bringing with it. 

To be sure, Japan’s core inflation gauge that does away with food and energy segments continues its rise, now close to 4.5% and not far off from a similar measure in the US which is just above 5.0% (but falling). Considering this, we have argued that Japan’s 10-year JGB yield below 0.5% looks mispriced when its equivalent US treasury is yielding 3.7%. 

We have recently covered much of our latest thoughts regarding BOJ’s curious stance which we think could be heavily influenced by MOF and the political establishment. Even reports that suggests BOJ is unlikely to move until next year’s likely general election clearly underline that BOJ is not only not data dependant but its policies are currently being heavily skewed by politics. 

After years of freely spending away public funds and borrowing at low rates that BOJ had helped suppress, it is appranet now that policies of Abenomics didn’t see higher rates coming. Alarmed by rising cost of government refinancing which has ballooned to nearly a quarter of Japan’s annual budget, we think the government is trying to keep rates down. This is especially the case as Kishida-san has huge spending plans to beef up Japan’s defence, child baring incentives and in the short term, large energy household subsidies that are due to expire in September.

The government also has yet to put forth any taxation plans leaving a high likelihood of Japan’s deficit increasing much more from here. The economic mess of Abenomics/Kuronomics have left Japan’s budget deficit approaching 300% of its GDP and BOJ now owning 60% of all outstanding JGBs. So even the high likelihood for a big increase in government bond issuance suggests that Japan’s long term rates need to head higher.

Come what may, Japan’s economic policy makers have a huge battle on their hands as the yen which is already plunging in value to multi-year lows against the Swiss Franc and Euro looks poised to test its October 22 lows against the dollar. We think currency speculators are most likely to test the resolve of MOF which is ultimately in charge of any intervention BOJ conducts. 

However, intervention alone may not not help this time and after MOF’s first attempt which may push up the yen for a day or two, speculators will likely quickly be back to attack that dollar/yen rate of 150 which policy makers proved sensitive to last year. Talks of weaker yen pushing up import prices have also re-emerged not helping BOJ’s case in justifying its ludicrously low inflation outlook for the rest of this year.

In fact, with Japan’s utility bills due to rise by up to 40% from this month on, and looking to raise headline inflation rate by as much as 0.5% in BOJ’s own calculations, while every 10% fall in the yen’s value against the dollar reportedly adding another 0.25% to the gauge, BOJ is now under huge pressure to revise its inflation outlook in July and more importantly, explain why it is not moving. 

Moreover, should Kishida’s government choose not to extend or cut the household subsidies in September, the short-term impact on raising headline inflation will likely be even bigger. As economists are scratching their heads baffled by BOJ’s inaction, we think plunging value of the yen will likely force authorities to act. But things look to get ugly in the short term. What is most surprising is that JGB market has yet to be attacked by short sellers again to also test BOJ’s resolve in keeping longer term rates suppressed. But that may transpire also.