Japan Gets Control and Abandons Currency Wars
22nd September 2016
I would like to acknowledge my colleague Stefan Scheuer and thank him for his collaboration on this topic.
The Bank of Japan (BoJ) has really done a lot of homework, and has introduced a new package to its Q.Q.E. cocktail. The BoJ is now seeking to “Get Control” of the Japanese government bond market yield curve, and steepen it.
In order to strengthen the banking and insurance sectors…in order to increase bank lending and bank profits.
A steep yield curve theoretically motivates banks to lend money, as banks borrow short-term at low rates and lend long-term at higher rates.
Here is a picture of what they are trying to do to the yield curve…the green line represents the curve’s current position…the blue line shows its position three months ago.
Click graph to enlarge
Past performance is not a reliable indicator of future results.
Japan is abandoning the currency wars!
This is a marked change, of course, from the previous focus on trying to weaken the Japanese currency (the Yen) in order to increase exports and corporate earnings when translating foreign currency profits back to Yen.
Investment implications: Demographics are still the main problem. The Yen could strengthen further, and the curve steepen.
But will this new finessing of the Quantitative Easing (QE) program work?
I do not think so. The initial weakness in the Yen and the strength of Japanese stocks may be short-lived.
Long Japanese Yen:
1. USD-JPY is driven by two fundamental factors:
a. Future expectations of a hike by the US Federal Reserve (Fed)…the Fed may hike in December.
b. Price of oil – Japan imports 100% of its energy needs. The collapse in the price of oil in the past two years has swung the Japanese trade deficit into a trade surplus, which supports the Yen.
2. Bear Steepener:
– Remain underweight long-dated Japanese government bonds with maturities longer than 10 years, as the BoJ will probably buy less of these bonds, and issuance of long-dated maturities will increase. Will it have any impact on improving Japanese growth dynamics, which is what is really necessary?
Answer: No. Demographics are the main problem, which the BoJ cannot influence. Japan remains mired in negative demographics, which structurally continue to cause sub-par growth and low overall aggregate demand.
So there is not enough demand to borrow money in Japan, as the growth outlook remains dim…continuing the trend of the past two decades.
This is not a recommendation or solicitation to buy or sell any particular security.
Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested.
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