If time travel were possible, Bank of Japan Governor Haruhiko Kuroda would almost surely transport himself back to July 30 and take his katana to interest rates.
The week since that no-action decision has been as brutal to Kuroda & Co’s credibility as the yen’s trajectory. The currency’s rally accelerated after the Federal Reserve eased on July 31. It intensified on August 2 when Donald Trump upped the ante on his trade war.
Now, the yen’s surge is taking on a life of its own as China beat the BOJ to the punch.
On Monday, Beijing let the yuan fall through the psychologically important 7-to the-dollar level. That prompted US President Trump’s White House to label China a “currency manipulator.” It also prompted traders to bid the yen up – it’s now up 7% since October and up nearly 4% so far this year.
This currency strength will hammer Japan’s already impacted exports. So where does this leave the BOJ? On the defensive in ways that could ratchet up tensions between the Trump White House and the Asian economies he sees as stealing American jobs.
A cross-currency domino effect
Though Trump’s tariffs are largely aimed at China, Japan is the biggest collateral-damage victim.
The 6.7% year-on-year plunge in exports in June was the seventh straight monthly drop. Real wages fell a sixth straight month in June, by 0.5%. Inflation is less than halfway to Tokyo’s 2% target.
And yet – nothing from the BOJ. Not even a modest recalibration of asset purchases to signal to markets that the BOJ remains on the job.
Explanations for why center on two challenges. One is a dearth of obvious levers to pull. Since 2013, the Kuroda BOJ hoarded half of the outstanding government bonds, drove yields negative and commandeered nearly 80% of exchange-traded funds.
Two, the @realDonaldTrump Twitter feed. With bilateral trade talks underway – a trial-by-fire Washington has foisted upon Tokyo – the BOJ has been reluctant to provoke Trump’s White House.
Time to act
Expect the BOJ to get back in the game, and soon. Team Kuroda has already fallen out of sync on global easing. The BOJ figured it could rest on its “pioneering policy” laurels. But panicky markets are now decidedly in “What-have-you-done-for-me-lately?” mode. As traders bid up the yen, Tokyo’s inaction looks like tacit approval.
Expect the BOJ and the Ministry of Finance to give verbal assurance and direction in the days ahead. On Monday, Japan’s top currency official, Yoshiki Takeuchi, warned Tokyo might act if “currency moves have a negative impact on the economy and financial markets.”
Expect stronger rhetoric, and threats of outright market intervention, if the yen continues to bulk up.
Expect, too, Abe’s team to ramp up fiscal stimulus efforts. And, of course, for the BOJ to come under growing pressure to maintain the gains its six-year-plus reflation made in Asia’s second-biggest economy.
Granted, those gains aren’t what Prime Minister Shinzo Abe pledged back in December 2012. The structural reform “big bang” he advertised took a back seat to aggressive BOJ easing. Even so, the yen’s 30% drop was fuel enough to power the longest expansion since the 1980s. That is in jeopardy as Trump’s trade war ravages Asia.
Raising the stakes
China’s unofficial currency devaluation raises the stakes yet higher.
In recent months, Trump has even turned his Twitter wrath on his own hand-picked Fed Chairman Jerome Powell. Last week, Powell caved in with a 25 basis-point rate cut for an economy that near 50-year unemployment levels simply doesn’t need. That tests Tokyo’s tolerance for a stronger exchange rate.
A weaker yuan is the last thing Japan needs. Its choice is either to stomach lost trade with China to placate Trump, or act in Japan’s interest. Japan’s exports to China fell 10% in June alone. Straddling these two challenges is made harder by Abe’s escalating trade spat with South Korea’s Moon Jae-in.
A yuan falling past 7 is also the last thing South Korea needs as growth wanes. In July, Korean exports to China fell 16.3%, while semiconductor shipments plunged 28%. The Bank of Korea and Seoul’s Ministry of Finance might be forced to take drastic action as the won rises versus the yuan.
This race to the bottom gets all the more precarious as the Fed, the People’s Bank of China and finance officials in Washington and Beijing act to safeguard domestic interests. Japan is already caught in the crossfire. As Kuroda and Abe work to shield Japan from incoming, they must tread carefully.
Go too far capping the yen, and Trump might pounce. He would almost surely direct his negotiators to turn the screws on Tokyo amid trade talks.
Do nothing, though, and see the yen head toward 100 from the current 106 range.
The odds favor Tokyo reasserting its authority to markets. Expect injections of fresh liquidity and increased BOJ asset purchases. Expect, too, Finance Minister Taro Aso’s team to be more assertive in capping the yen – in ways that could risk Trump’s ire at the worst possible moment for global markets.
The best time to remind punters that officials are on top of Japan’s troubles was last week. The second best time is this very moment.