Japan doesn’t have easy money, but it needs it

Sometimes you can only shake your head at the confusion surrounding monetary policy.

The BOJ has a set a 2% inflation target.  While inflation has risen a little bit, it’s still well short of the target.  More importantly, market indicators suggest that Japan is unlikely to hit the 2% target going forward.  Thus this story makes no sense:

“The BOJ’s board members expect that prices will reach 2 percent around fiscal 2019. If this happens, there’s no doubt that we will consider and debate an exit,” Bank of Japan Governor Haruhiko Kuroda told parliament.

Can someone explain to me why the BOJ would believe that inflation will soon hit 2%? Ten-year bond yields are currently close to zero, vs, 2.9% in the US.

With prolonged easing straining bank margins, some analysts have called on the BOJ to raise rates before inflation hits 2 percent, arguing that it was too high a level to aim for in a country that has suffered from two decades of deflation.

If the BOJ tightens policy by raising rates before hitting 2% inflation, within a year or two they’ll be back down to zero.

PS.  Can someone tell me if I’m reading this table correctly?  Are forward discounts on the dollar quoted in basis points?  Does this table imply the 30-year forward dollar is trading at only about 50 yen?


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25 Responses to “Japan doesn’t have easy money, but it needs it”

  1. Gravatar of Michael Makdad Michael Makdad
    4. March 2018 at 20:58

    The rates are in basis points and not annualized. If covered interest rate parity held, the yen would have to be trading at 50 or 60 to the dollar out 30 years, but the most liquid markets should be around three months

  2. Gravatar of ssumner ssumner
    4. March 2018 at 21:01

    Michael, You said:

    If covered interest rate parity held, the yen would have to be trading at 50 or 60 to the dollar out 30 years,”

    Thanks, I presume you mean the dollar is expected to trade at that value in 30 years?

  3. Gravatar of Michael Makdad Michael Makdad
    4. March 2018 at 21:05

    Yes, and I meant that if you compound the difference between USD and JPY interest rates over 30 years to see anything else would be surprising

  4. Gravatar of ssumner ssumner
    4. March 2018 at 22:30

    Michael, Yes, and I’d guess that financial types think in terms of the interest rate spread causing the forward exchange rate of 50, whereas monetary economists like me think in terms of the forward exchange rate of 50 causing the interest rate spread. Does that seem right?

  5. Gravatar of dtoh dtoh
    4. March 2018 at 22:41

    Forward spreads are entirely a function of interest rate differentials. If they weren’t they would be instantly and massively arbitraged.

  6. Gravatar of Tildeon Tildeon
    5. March 2018 at 00:57

    They are quoted in ‘pips’, so with spot USDJPY trading at 105.57, the 30Y points trading at -5620, means that the forward USDJPY rate in 30Y time is: 105.57 – 5620 / 100 = 49.37.

    @dtoh – that isn’t entirely true. Cross-Currency basis is a measure of how much this relationship is failing to be forced. Currently the USDJPY 30Y XCCY basis is trading at -50bps.

  7. Gravatar of Tildeon Tildeon
    5. March 2018 at 01:08

    To be fully explicit on USD vs JPY 30y rates:

    The 30y OIS rate in Japan is 0.67%, which is a discount factor of 0.81.
    The 30y OIS rate in US is 2.51%, which is a discount factor of 0.47.

    The ratio of discount factors is 0.58, so we’d expect forward USDJPY currency to be 61.05. The implied forward is 49.4. This difference is accounted for in ~50bps of XCCY.

  8. Gravatar of Benjamin Cole Benjamin Cole
    5. March 2018 at 02:28

    The Bank of Japan is routinely described as “ultra easy” by Reuters and others in the financial media, but then also by (otherwise) knowledgable Western economic observers.

    “The Bank of Japan must avoid a premature exit from its ultra easy policy and consider ramping up stimulus if needed to pull the economy out of deflation, Masazumi Wakatabe, one of the two nominees for BOJ deputy governor, said on Monday.”—Reuters today.

    Bad reporting and bad economics.

    Still, the Japanese central bankers seem better than those in Washington DC. The J-bankers are calling for more stimulus, and not prematurely worrying about inflation.

    Actually, the whole BoJ and Japan situation is….well, not textbook.

    Okay, Tokyo runs large national budget deficits, the BoJ runs constant QE (and when would the BoJ ever sell the JGBs, and they own 45% outstanding and counting), they have negative interest on reserves, and there are 150 job openings for every job seeker in Japan.

    And they cannot hit 1% inflation.

    Side note: Beijing today called for 3% inflation in 2018.

  9. Gravatar of HL HL
    5. March 2018 at 04:55

    My experience is that most FX traders think of the rate differential and forward curve shape of FX pairs as “hedging cost” without even thinking too much about the obvious purchasing power parity and interest rate parity dimensions. It is not uncommon to see experienced G10 currency traders commenting on the forward curve as if it is some sort of nuisance. It amuses me to no end.

    At the end of the day, forwards beyond 1 year is too illiquid to be used regularly by end clients, so these are simple logical calculations based on swap markets or yields. Basically, that 30 year USDJPY around 50~60 would be an extra field on the screen that is never used by anyone in the market. At least that’s how I look at it. Think of Bloomberg engineer creating an extra field and populating the info on the basis of covered rate parity instead of market participants actively taking a view on the pair and then affecting rates market….

  10. Gravatar of Julius Probst Julius Probst
    5. March 2018 at 07:59

    Benjamin Cole, I agree that the Japanese situation is quite special given that they have recently monetized almost 50% of their debt outstanding and I think nobody expects them to sell those securities in the near future or even ever again.
    The BOJ with Kuroda was successful in raising nominal GDP and ending decades of deflation over the last few years.
    I think that from an economic point of view they could be more successful in raising/achieving their inflation target by implementing something like a “fixed exchange rate regime”. Just depreciate the YEN by 2% vs the dollar on an annual basis and you reach your higher inflation goal.
    They could enforce this regime by buying American government bonds instead if they run out of Japanese bonds to buy (buying foreign bonds gives you more bang for the buck anyway – a suggestion that Jeffrey Frankel once proposed for the ECB).
    Obviously, such a regime might be hard to defend politically.

  11. Gravatar of ssumner ssumner
    5. March 2018 at 10:03

    dtoh, I understand that. The question is whether the 30 year forward yen is 50 because US interest rates are 2% higher than Japanese rates, or whether US interest rates are 2% higher than Japanese rates because the forward yen is 50.

    Thanks Tildeon.

    Thanks HL.

    Julius, They don’t even need to depreciate their currency at 2% a year, just fixing it to the dollar would give them 2% inflation in the long run.

  12. Gravatar of rtd rtd
    5. March 2018 at 10:52

    I was reading the Brokkings transcripts and noticed this quote from Yellen after being asked about raising the inflation target:
    “So that to me is not — it’s certainly worth considering the costs and benefits, but it’s not a clear, “yes, we should have a higher target.” That takes you to other systems, like nominal GDP targeting that has some interesting advantages, or price level targeting. And I think these things are worth considering.”

  13. Gravatar of Cooper Cooper
    5. March 2018 at 13:46

    Since 2012, the BOJ’s share of JBG ownership has increased from 10% to 46%. At what point does the Bank of Japan own basically all of Japan’s debt?

    Can they quietly wipe these bonds off the balance sheet without spooking the markets?

  14. Gravatar of Tildeon Tildeon
    5. March 2018 at 15:14

    @HL – “At the end of the day, forwards beyond 1 year is too illiquid to be used regularly by end clients, so these are simple logical calculations based on swap markets or yields. Basically, that 30 year USDJPY around 50~60 would be an extra field on the screen that is never used by anyone in the market. At least that’s how I look at it. Think of Bloomberg engineer creating an extra field and populating the info on the basis of covered rate parity instead of market participants actively taking a view on the pair and then affecting rates market….”

    This tallys with my experience of FX traders, however rates traders certainly do consider all the parts of the 30y USDJPY. Cross-currency basis trades liquidly out to 30 years, typically by rates traders. Both swap rates trade very liquidly out to 30ys.

    (I’ve even known of 10y+ FX options trading, but that’s a story for another time).

  15. Gravatar of B Cole B Cole
    5. March 2018 at 17:19

    Julius–

    Excellent suggestions.

  16. Gravatar of Prakash Prakash
    5. March 2018 at 21:11

    @julius

    What about gold? If you buy any country’s bonds, it sounds like a trade war move, but gold is no one’s baby. Why can’t the BOJ buy gold?

  17. Gravatar of ssumner ssumner
    5. March 2018 at 21:42

    rtd, Thanks, that’s interesting.

  18. Gravatar of dtoh dtoh
    6. March 2018 at 22:31

    @Scott,
    Does the crowing rooster cause the sun to rise. If you have spent time on a trading desk or a farm, you will know the answer to the question.

    @Tildeon
    Of course regulatory constraints, transaction costs, differences in credit perception are going to cause some variation from the theoretical forward especially given the lack of liquidity that far out. Obvious and not interesting.

  19. Gravatar of ssumner ssumner
    7. March 2018 at 14:04

    dtoh, A trading desk is not a good place to learn macroeconomics, its a good place to learn finance.

  20. Gravatar of dtoh dtoh
    7. March 2018 at 16:08

    Scott,
    It’s a great place to learn markets. Not such a great place to learn finance.

  21. Gravatar of Tildeon Tildeon
    8. March 2018 at 02:46

    @dtoh
    “Of course regulatory constraints, transaction costs, differences in credit perception are going to cause some variation from the theoretical forward especially given the lack of liquidity that far out. Obvious and not interesting.”

    XCCY is definitely driven by regulatory constraints. Transaction costs and credit perceptions are irrelevant here.

    It has nothing to do with ‘that far out’ or liquidity (these products are liquid).

    3M xccy – -30bps
    1Y xccy – -45bps
    2Y xccy – -48bps

  22. Gravatar of ssumner ssumner
    8. March 2018 at 10:05

    Tildeon, I recall reading that this is a recent phenomenon, caused by the post-2008 regulatory changes. Is that right?

  23. Gravatar of Tildeon Tildeon
    8. March 2018 at 23:58

    Fairly recent.

    JPY 5Y XCCY traded between

  24. Gravatar of Tildeon Tildeon
    8. March 2018 at 23:59

    Fairly recent, 5Y JPY XCCY did trade consistently at non-zero levels pre-2008, but the crisis really kicked the market off.

  25. Gravatar of ssumner ssumner
    12. March 2018 at 15:59

    Thanks Tildeon.

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