Yen’s rise may mark limit for monetary policy

5 min read

The sudden strength of the Japanese yen isn’t just a headache for Japan, it is an illustration that we may be reaching the limits of what monetary policy can accomplish.

The yen has rocketed higher against the dollar in recent weeks, touching 17-month highs and having gained 11 percent since the Bank of Japan introduced negative interest rates in January.

As the Abenomics plan to revive the economy is partly predicated on a weak currency spurring exports, this has not gone down well in Tokyo. Chief Cabinet Secretary Yoshihide Suga warned on Monday that the Group of 20 rich nations’ agreement to eschew competitive currency devaluations was no bar to Japan intervening to stop “one-sided” moves.

With the International Monetary Fund holding meetings later this week, now would be an embarrassing time for Japan to sell yen on currency markets. But to view this as a short-term problem of financial diplomacy is to underestimate the depth of the problem.

“Already, there are important signs that the ECB and the BOJ are losing their influence on the markets,” hedge fund manager Stephen Jen of SLJ Macro Partners wrote in a note to clients. “The latest correction in dollar-yen, for example, is a verdict that the BOJ’s policies are no longer potent.”

Negative interest rates in Japan have spawned negative unintended consequences. Stocks have fallen 13 percent, with banks, whose very business model is undermined, the hardest hit. That has left many with the belief that the Bank of Japan is constrained: neither negative rates nor its massive purchases of stocks and bonds are having the intended effect.

Many foreign investors, who had been enthusiastic supporters of the Abenomics experiment, have duly turned sour. Since just before negative rates began, foreigners have sold a net $46 billion in Japanese stocks. Many, including hedge funds, are unwinding trades in which they bought Japanese stocks while selling yen, which often moves in the opposite direction, as a safety measure. Sell the stocks, as many now are, and you also buy the yen.

Japan’s problems are also partly made in Washington, where the Fed has turned less aggressive, sending U.S. interest rates lower and halving the real, or inflation-adjusted, difference between higher U.S. and lower Japanese bond yields. Buying Japanese bonds just isn’t as unattractive as it was in January, ironically, and the market seems to doubt the BOJ’s ability to make it a worse deal.

Acting similarly, not in concert

Thus we have the Bank of Japan – and its government — painted into a corner.

The central bank already owns about a third of all outstanding government bonds and every month buys about as much as the government issues. Not much room to do more there.

Interest rates could be taken lower, but the costs now seem a lot easier to spot than the benefits.

As for intervention to sell the yen and drive it lower, that historically has been a game that only works longer-term when all sides are playing toward the same end.

Certainly, Japan can do yet more fiscal stimulus, and may well be likely to, with the alternative being admitting that the Abenomics experiment is a busted flush.

The weakening dollar since the Group of 20 meeting in January has fueled speculation of a tacit agreement, or secret deal, which might make yen strength simply collateral damage to solving bigger issues. Such a deal is highly unlikely, though it is certainly true that in taking the pressure off the Chinese yuan, global policymakers find themselves with one huge and disruptive issue less with which to contend.

More likely is that major players truly are happy to behave as if they’ve reached a deal to limit the dollar’s rise. That takes us back to the effective limits of monetary policy and beggar-thy-neighbor currency depreciations.

“The winners of the currency war battles may have decided that they were not benefiting enough to offset the negative impact of the ancillary asset market volatility that emerged,” Steven Englander, currency strategist at Citibank, wrote to clients.

“Basically, they were acknowledging policy ineffectiveness or at least monetary policy ineffectiveness, and the G20 statement pretty much admitted that.”

The upshot is more volatility, as governments and central banks will be reluctant to intervene or push rates lower, leaving markets to move as they will.

The bigger question is how investors and markets react once they realize they are working without the safety net they’ve enjoyed since the financial crisis.

A world with less-active central banks was inevitable, but it does not have to be a lot of fun.

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

James Saft