USDJPY wobbled on less dovish BOJ talks; Gold, Dow gains

On Tuesday (19th December), some focus of the market was also on BOJ after non-stop hawkish/dovish jawboning by BOJ/JP policymakers to exit NIRP (selective reverse repo rate) and YCC policy. As a result, USDJPY stumbled from around 152 in mid-October to almost 140 in late December. Also, a dovish hold by the Fed on 13th December helped BOJ/JP in supporting the local currency (JPY) against USD.

Japan’s Kishida Government is also under growing public pressure in recent times amid soaring core inflation and subdued wage growth. Although higher USDJPY is positive for Japan’s export-savvy economy, at the same time it’s causing significantly higher imported inflation as Japan is dependent on imported food & fuel/various commodities. Japan’s PM Kishida is now almost begging corporates/private sector to increase the salary of Japanese workers adequately/significantly to cool growing social unrest in Japan.

On Monday, before BOJ, Kishida said:

·         We're at a critical place for escaping from deflation

·         We will work on steps to pass labor costs on to customers

·         Wage hikes at small and medium-sized businesses are essential

·         I would like to ask businesses for bigger pay hikes this year

·         Wage growth is outpacing prices (inflation) required for a virtuous cycle

·         I exchanged views with labor and business leaders

In any way, USDJPY again recovered from around 140 to almost 149 in mid-January’24 on a dovish hold by BOJ (as usual) on 19th December coupled with a desperate effort by various Fed policymakers in support of higher for longer policy at least in H1CY24 (no rate cuts; only QT tapering). Fed Chair Powell boosted the year-end Santa Rally in stocks by simply indicating that FOMC policymakers are now actively discussing rate cuts, which is logically the next step if core inflation drops as being expected by the FOMC in their SEP/dot-plots; but Powell also indicated rate cuts, if any would be in the distant future, not imminent.

Although various BOJ/JP officials are now jawboning less dovish under the leadership of new BOJ Governor Ueda, and PM Kishida, the market was unanimously expecting a hold this time as usual as Japan can’t afford higher bond yield (higher borrowing costs) further as it’s already paying around 13-15% of tax revenue as interest on public debt, which is a red line for AEs, everything being equal.

As unanimously expected, on Tuesday BOJ kept all policy rates unchanged. The Bank of Japan (BOJ) kept its key short-term special deposit facility (reverse repo) key policy rate unchanged at -0.1% and that of the long-term reverse repo rate equivalent to 10Y JGB yields at around 0.00% (~0.10%) in its Jan’24 meeting by unanimous vote. At the same time as highly expected, the BOJ left unchanged +1.0% as a ‘loose upper bound’ rather than a rigid cap for a long-term 10Y JGB bond.

Meanwhile, in a quarterly outlook, the BOJ slashed CPI readings for FY24 to +2.4% from October's projections of +2.8%, reflecting a recent decline in oil prices. But BOJ now projected FY25 CPI at +1.80% against earlier projection of +1.70%. More importantly, BOJ kept its core inflation projection unchanged at +1.90% for both FY24 and FY25 against earlier projections. BOJ Policymakers also cut their 2023 real GDP growth forecast to +1.8% from earlier +2.0%. For FY 2024, the bank revised its real GDP forecast to +1.2% from earlier +1.0%, supported by pent-up demand.

After the decision, BOJ Governor Ueda commented that any potential rate hike would initially seek to maintain BOJ policy in support of the economy and would strive to minimize disruptions. Expanding on the newly incorporated language in the central bank's quarterly outlook report, Ueda noted that the confidence in achieving the BOJ's projections has steadily grown.

Although, BOJ is famous for its negative interest rate policy (NIRP), in reality, the effective reverse repo rate is around 0% or +0.10%, while the repo rate is +0.30% and no banks ever make the ‘complementary deposit’ above a certain limit in a special current account with BOJ, so that it has to pay an interest of +0.10% to BOJ under reverse repo rather than the usual opposite.

BOJ’s repo rate is still now +0.30% (unchanged since Dec’2008) against the Fed’s current rate of +5.50% and ECB’s +4.75% despite comparable core CPI; 6M average of around +4.30%, resulting in a deep negative real repo rate around -4.00% against Fed’s +1.20%. The bank lending rate (BLR) of Japan is now around +1.48% against the US +8.50% and China +3.45%.

BOJ is trying to keep the 10YJGB bond yield at minimum levels, now below +1.0% by sheer jawboning and a false perception of a negative interest rate; in reality, BOJ’s repo rate is +0.30% against Fed’s +5.50%, while the effective reverse repo rate +0.10% against Fed’s +5.40%. In this way, due to the very low repo rate, reverse repo rate, and bank lending rate, banks & financials have very low NIM compared to their US peers, leading to subdued wage growth and the vicious cycle of deflation. BOJ officially maintains a negative reverse repo rate (tiered), so that banks are discouraged from parking their excess funds at BOJ and encouraged to lend to the real economy (forced lending policy is World’s financier, especially in US bonds, startups and infra projects).

Highlights of BOJ MPC statement: 23rd January’2024

·         BOJ Rate Decision Actual -0.10% (Forecast -0.1%, Previous -0.10%)

·         BOJ board forecasts lower median real GDP growth of +1.8% for fiscal 2023 compared to +2.0% in October

·         We will keep easing patiently for the price goal with wage gains

·         Board's CPI fiscal 2024 median forecast at +2.4% vs +2.8% in October

·         Board's Core CPI Fiscal 2023 Median Forecast remains at +2.8% compared to +2.8% in October

·         Maintains status quo: 10-year JGB yield's 1.0% reference rate remains unchanged

·         BOJ Keeps 10-Year JGB Yield Target at Approximately 0%

·         BOJ Keeps Policy Rate at -0.1%

·         BOJ maintains 10-year Japanese Government Bonds (JGB) yield target of around 0%

Highlights of BOJ Quarterly Report:

·         Japan's Financial System Remains Stable Overall

·         Inflation expectations rising gradually over medium to long-term

·         Japan's output gap improving, expected to gradually expand ahead

·         Inflation Expected to Gradually Reach BOJ's Target by End of Projected Period

·         Moderate Increase in Consumption Continues

·         Core Consumer Inflation falls below 2.5%, attributed to a moderate increase in service charges

·         Vigilance Needed for Financial and FX Market Moves and Their Impact on Japan's Economy and Prices

·         Japan's economy anticipated to maintain a moderate recovery

·         Uncertainty persists, but chances of achieving sustained 2% inflation gradually increasing

·         Continues monetary easing while adapting to developments

·         Japan's potential growth rate to be between 0.5-1.0%

·         BOJ closely watching risks, expects a virtuous cycle of wages and prices to strengthen ahead

·         Additional easing steps possible if necessary

·         Risks balanced for the economy and prices up and down

·         BOJ to extend loan disbursement deadline for bank lending stimulus fund measure by one year

·         Monitoring intensification of the virtuous cycle between wages and prices

·         Need to closely monitor financial and currency markets and their impact on Japan's economy and prices

·         Economic risks remain generally balanced

·         Sees high uncertainty over Japan's economy and prices

Highlights of BOJ Governor Ueda’s comments: BOJ presser/Q&A: 23rd January’2024

·         The probability of reaching the 2% inflation target increases steadily

·         Policy change is possible even when there is no update to the quarterly outlook

·         We can't say now how long the easy policy will remain after the negative interest rate policy ends

·         We don't have a preconceived order of policy steps when changing policy

·         Hiking rate before the 2% target hit raises the risk of deflation

·         The 2% inflation target should not be modified so easily

·         We're going to avoid discontinuity over long-term JGB buying at exit

·         Expectations for soft landing in the US economy are growing

·         The consideration of whether to continue ETF buying is a separate issue from whether to sell.

·         We will have more data at the April meeting compared to March

·         Discusses using economic data for wages at small firms

·         No Requirement for All SMEs to Increase Wages Significantly for Policy Change

·         No significant macroeconomic impact from the Noto Peninsula earthquake currently

·         Progress made on deflation is defined as the negative inflation rate

·         A positive outlook might allow for policy change despite negative real wages

·         Anticipates moderate consumption growth to continue after spring thanks to wage hikes

·         More Data Available at April Policy Meeting Compared to March

·         Expects accommodative conditions to persist for some time

·         Services inflation shows a gradual rise even after excluding temporary factors

·         Expect BOJ to collaborate closely with the government, and implement suitable monetary policy to achieve its price goal sustainably and stably while supporting wage growth

·         Ending negative interest rates policy when 2% inflation is achieved

·         Output gap doesn't need to turn positive to achieve inflation target

·         More firms have decided on wage hikes this year compared to last year

·         Expects Moderate Wage Hikes, with Reduced Uncertainty Compared to Last Year

·         Foresees further rate hikes when exiting negative rate policy

·         Acknowledges negative interest rate policy's side effects

·         No way to measure how close we are to ending negative rates

·         Notes peak of 'first force' inflation, gradual emergence of 'second force' wage-price cycle

·         Import prices' impact continues, but it is past its peak

·         To closely monitor earthquake's impact on supply chains, tourism, and consumer confidence

·         Notes incomplete understanding of the economic impact of the Noto Peninsula earthquake

·         Have heard encouraging comments from big firms on wage hikes

·         The likelihood of achieving the 2% inflation target is gradually rising

·         Maintains a stance of carefully examining price trends

·         Inflation target achievement is more likely as the economy follows the existing price outlook

·         Ueda is confident in achieving the price target

·         Confirms economy progressing in line with forecast

·         Believes major policy discontinuity can be avoided given current prices and economic outlooks

·         To review monetary easing measures, including negative interest rates, upon reaching the 2% inflation target

·         Affirms the presence of a virtuous cycle of wages and prices

·         To closely monitor the results of spring wage discussions

·         Encouraged by big companies' comments on wage hikes

·         The probability of reaching the 2% inflation target increases steadily

·         Prepared to take additional easing measures if needed

·         Must monitor financial and FX market impact on Japan’s economy and prices

·         Expect Japan's economy to slowly recover in the coming months

Market impact of BOJ’s policy:

·         BoJ Governor Ueda: Probability of reaching 2% inflation target increasing steadily (Yen strengthens)

·         BoJ keeps the rate unchanged, and will continue easing patiently for "price goal with wage gains". Median forecast for core CPI in 2024 was seen lower compared to October expectation (Yen weakens)

·         BoJ watchers see the rising case for an April rate hike on wage talks

Full Text of BOJ statement of monetary policy: 23rd January’2024

“ At the Monetary Policy Meeting held today, the Policy Board of the Bank of Japan decided upon the following.

(1) Yield curve control

a) The Bank decided, by a unanimous vote, to set the following guidelines for market operations for the intermeeting period.

The short-term policy interest rate: The Bank will apply a negative interest rate of minus 0.1 percent to the Policy-Rate Balances in current accounts held by financial institutions at the Bank.

The long-term interest rate: The Bank will purchase a necessary amount of Japanese government bonds (JGBs) without setting an upper limit so that 10-year JGB yields will remain at around zero percent.

b) Conduct of yield curve control (a unanimous vote)

The Bank will regard the upper bound of 1.0 percent for 10-year JGB yields as a reference in its market operations, and to encourage the formation of a yield curve that is consistent with the above guideline for market operations, it will continue with large-scale JGB purchases and make nimble responses for each maturity by, for example, increasing the amount of JGB purchases and conducting fixed-rate purchase operations and the Funds-Supplying Operations against Pooled Collateral.

(2) Guidelines for asset purchases (a unanimous vote)

With regard to asset purchases other than JGB purchases, the Bank decided to set the following guidelines.

a) The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) as necessary with upper limits of about 12 trillion yen and about 180 billion yen, respectively, on annual paces of increase in their amounts outstanding.

b) The Bank will maintain the amount outstanding of CP at about 2 trillion yen. It will purchase corporate bonds at about the same pace as prior to the COVID-19 pandemic so that the amount outstanding will gradually return to the pre-pandemic level of about 3 trillion yen. In adjusting the amount outstanding of corporate bonds, the Bank will give due consideration to their issuance conditions.

The Bank decided, by a unanimous vote, to extend by one year the deadline for loan disbursement under the Fund-Provisioning Measure to Stimulate Bank Lending.

With extremely high uncertainties surrounding economies and financial markets at home and abroad, the Bank will patiently continue with monetary easing while nimbly responding to developments in economic activity and prices as well as financial conditions. By doing so, it will aim to achieve the price stability target of 2 percent in a sustainable and stable manner, accompanied by wage increases.

The Bank will continue with Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, aiming to achieve the price stability target, as long as it is necessary to maintain that target in a stable manner. It will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds 2 percent and stays above the target in a stable manner. The Bank will continue to maintain the stability of financing, mainly of firms, and financial markets, and will not hesitate to take additional easing measures if necessary.”

Overall, the market was expecting clear ‘exit’ language in the BOJ statement followed by a similar indication by Governor Ueda. But that’s not the case; while Ueda sounded more hawkish than expected and also indicated some ‘real action’ in April’24, it seems that BOJ (Bank of Jokers) has now lost all types of credibility for never-ending jawboning (bluffing) of ending at least NIRP and YCC stance. At the same time, Ueda may be also concerned about the Fed’s planned rate cuts in 2024, which will make the JPY stronger, and import inflation lower. Thus BOJ may not exit its ‘powerful’ NIRP/YCC instruments in reality.

Conclusion:

Japan’s core inflation (ex-food & fuel) was around +3.7% in December from +3.8% sequentially, eased from a recent high of +4.3% in July-August’23. Japan’s core inflation is still substantially higher than the Jan’23 reading of +3.2% as well as the BOJ target of +2.0%. In 2019 (pre-COVID), Japan’s core inflation was hovering around 0.5%, and fell below 0% during COVID (Jan’20-Mar’22); in Mar’22 it was around -0.7% but soon jumped above +0.8% in Apr’22 as oil/energy soared after Putin’s Ukraine invasion started in Feb’22. Japan is dependent on imported fuel/energy and food. Thus Japan is also a big victim of Russia-Ukraine/NATO/G7 geopolitical tensions and subsequent economic sanctions on various Russian commodities (like EU/Europe). Further Israel-Hamas Middle East geopolitical tensions along with devalued currency, the threat of more imported inflation was quite prominent; but lower oil/energy prices also brought some relief.

Japan suffered double-digit inflation (hyperinflation) and also above +20% core inflation in the 1970s. Thereafter lower core inflation in Japan may be a combination of various factors: lower fuel tax, lower housing demand/price, lower growth in household income, lower pricing power by producers, unfavorable demography/aging population, and excessive automation; in brief, demand is lower than supply in Japan. But now, the situation has changed drastically and JP's economy is suffering from huge imported inflation. A local household/lower-middle class family now needs a minimum JPY 400-500K.month for a comfortable standard of life against the present average JPY 450K wage.

And BOJ is not ready to hike the policy rate despite higher core CPI than the target since Oct’22 because BOJ wants to see sustainable higher core inflation due to elevated demand, wage pressure and thus not ready to normalize policy as BOJ thinks the present elevated core inflation is a result of supply shock and currency depreciation (higher imported inflation) and not demand driven-thus transitory amid no signs of wage inflation. On the other side, producers are not ready to hike prices significantly for the fear of losing market share (having no pricing power) and thus also not in a position to hike wages meaningfully.

BOJ/JP Government wants to see wage growth above +2.0% on a sustainable basis, which is not the case at all for long. There is a deflationary mindset in Japan, but Japan is the biggest exporter of capital due to almost zero yield locally; it’s the biggest foreign bondholder for the U.S. And higher Japanese bond yield, say above +1.50% may cause capital flight back into Japan, and also cause higher global bond yield, including U.S. Thus the risk trade got some boost Tuesday after BOJ as JGB/US/EU bond yield falls to some extent; Gold got a boost.

Overall, there is a huge policy divergence between the Fed and BOJ. If we adjust the average core inflation, the real U.S. /Fed repo rate is now around +1.20% against BOJ/Japan’s -4.00%. Also, BOJ is still running QE, while Fed is on QT. This is causing huge JPY depreciation against USD and even EUR, and GBP, causing a vitreous cycle of higher imported inflation and stagflation despite the advantage in exports. Also, geopolitical tensions with Russia and China are causing significant supply chain disruptions in Japan, causing more imbalances between constrained supply and demand.

As per Taylor’s rule, for Japan:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(4.00-2.00) =0+2+2=4.00%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation=4.00% (2023 average)

As per Taylor’s rule, Japan’s repo rate should be around 4.00% instead of the present +0.30%. Even if we assume a potential output growth gap of around -1%, Japan’s repo rate should be around +3.00% in the long run.

Normally, a Central Bank should do its job to bring down inflation/ensure price stability by hiking rates into the restrictive zone (real positive rate) so that the resultant higher borrowing costs curtail demand/consumer spending, corporate and even government spending, allowing constrained supply side of the economy matches, and ultimately inflation normalizes/falls. This is exactly what is being done by the Fed, ECB, BOE, and almost all other G20 central banks, where core inflation is still running hot.

But despite that BOJ/Japan Government is not ready to hike or even normalize/exit the current ultra-easy monetary policy as Japan is the only among few major economies in G10, which is paying around 12-15% of its tax revenue as interest on a huge public debt against U.S. 15% and EU/China’s 5.5%, far ahead of the AEs, which is a red flag and thus despite various narratives, BOJ is not in a position to normalize policy rate even after core inflation now hovering above +4.0%, substantially higher than the target.

Japan/BOJ has no option but to keep the bond yield/coupon rate at an artificially ultra-low level to keep borrowing costs minimal, so that it does not go above the 15% of the revenue red line. Japan/BOJ improved the borrowing cost ratio to 11.67% in FY22 from 13.50% in FY21 (relative to total revenue). BOJ now holds almost 50% of the total JP public debt.

But decades of artificially lower bond yield environment are also weakening Japan’s bank & financials, wage growths, and overall consumer spending. Japan is now entering a deflationary to a stagflationary cycle. If core inflation continues to surge and becomes sticky/elevated around 5%, then BOJ’s ultra-easy monetary policy may cause more devaluation for the currency/Yen and cause more imported inflation, everything being equal (despite BOJ/Japanese government jawboning that they are ‘watching’ Yen movement).

Bottom line:

BOJ may normalize its symbolic special reverse repo rate of -0.10% in H2CY24, when the Fed starts to cut, which will cause lower USDJPY, lower imported inflation, higher JGB bond yields, higher NIM/NII for banks & financials and higher wage growths and an end of the vicious cycle of deflation (?).

Market impact:

BOJ policy impact:

Less hawkish hold; USDJPY jumped; export-heavy JP stocks also soared; Wall Street, EU stocks also boosted on lower bond yields; USDJPY made a high around 144.95 soon after BOJ statement, which didn’t mention any ‘exit’ language. But USDJPY also slips to around 143.55 as BOJ Governor Ueda sounded more hawkish than expected about the ‘April exit’ (?). On Tuesday, Wall Street Futures surged amid lower bond yields, lower USD, and soft landing optimism amid upbeat/mixed economic data & earnings reports Gold also got some boost on lower USD.

Looking ahead, whatever may be the narrative, technically, USDJPY (148.15) now has to sustain over 150.00 for a further rally towards 152.00-153.00; otherwise, sustaining below 149.50 may further fall to 147.50/146.75-146.00/145.00 and further to 144.00/142.85-141.00/140.00 in the coming days.