An Unexpected Climb-Down

Ahead of the G-20 meeting in Russia this Thursday, the stance on the yen's recent decline has been softened by a most unusual source: Japan's new finance minister Taro Aso, who only a few days earlier still spoke of employing the methods of 1930s finance minister Korekiyo Takahashi as a means of ending Japan's economic slump.

Naturally he is suspected of just trying to blunt the criticism he will likely encounter at the meeting, and there is probably some truth to that. And so Aso informs us that the 'yen has fallen too far too fast' and that this was 'not expected'.

Bloomberg reports:

“Japanese Finance Minister Taro Aso said the pace of the yen’s weakening has been too fast, speaking a week before a meeting of global finance chiefs where Japan’s currency stance is forecast to be an issue.

Aso’s comment to reporters in Tokyo today came after he earlier told lawmakers the government hadn’t anticipated a rapid move to around 90 per dollar. The yen slumped 13 percent since mid-November in anticipation of monetary stimulus advocated by Shinzo Abe, who took office as prime minister in December. It rose as much as 1.6 percent today, the most since March 2011.

The yen’s drop spurred criticism abroad, with Aso’s South Korean counterpart complaining about the risk to his nation’s exports and Russia last month warning about the potential for reciprocal action to drive down exchange rates. Finance ministers and central bank governors from the Group of 20 nations are scheduled to meet in Moscow next week.

“Aso may be trying to cool the market’s momentum as European authorities are criticizing Japan’s policies,” said Junko Nishioka, chief economist at RBS Securities Co. in Tokyo and a former BOJ official. “His comments seem to be inconsistent: one moment he’s talking down the yen, the next he’s talking it up.”

The yen was up 1.2 percent at 92.53 per dollar as of 10:57 a.m. in London. It earlier increased the most since March 17, 2011, after Aso said in Parliament that “the yen’s sudden move from 78 or 79 to 90 was not something we anticipated.”


(emphasis added)

It seems quite likely actually that Aso was thinking about the upcoming G-20 meeting, where Japan 'may be asked to stop talking about the currency' according to Bloomberg.

However, we think there is actually more to it than that. Thinking about the yen's decline, it occurred to us that the threat of inflationary measures by the BoJ is probably only one factor driving the recent move. The other factors are Japan's deteriorating current account, and the 'risk on' climate in the world's stock markets, which has furthered not only the decline in the yen, but also a sizable decline in the Swiss Franc. Moreover, the JGB market has yet to react to these developments, although as we have previously pointed out, CDS on JGBs already evince growing apprehension.


The Upcoming Appointment of the BoJ Governor

In light of recent reports that Japan's entrenched financial bureaucracy is pushing back a bit and trying to get prime minister Abe to settle for a 'compromise candidate' as the next governor of the BoJ, Aso's climb-down may actually also have to do with this particular backdrop.

Below is a chart of the continuous 10 year JGB futures contract. As can be seen, this market continues not to believe that a marked change in the BoJ's policies is really going to happen. Or let us rather say: it does not believe that  further quantitative easing measures will be any more successful in generating consumer price inflation that the ones that have been attempted in the past. Moreover, one must not forget that the BoJ is generating artificial demand for JGBs as well. As long as actual monetary inflation as well as inflation expectations remain in check, nothing will therefore substantially change for the JGB market – not yet, that is.



10 year JGB future

A weekly chart of the 10-year JGB futures contract over the past five years – click for better resolution.



Still, both Japan's government as well as the bureaucracy and the biggest holders of JGBs (pension funds and banks) must be worried about the potential for this market to finally break down. Due to the government's extremely high debt load and its large ongoing deficit relative to tax revenues, any sustained rise in interest rates could spell utter fiscal doom.

We don't doubt that Abe's government is well aware of this wrinkle. In other words, if they really succeed in engendering an unmooring of inflation expectations, the saying 'be careful what you wish for' will apply.

Much will therefore depend on who is actually nominated to the top post at the BoJ. According to Bloomberg, these are the main contenders for the job:

“Potential candidates cited by analysts and local media reflect a range of monetary policy outcomes. While Asian Development Bank President Haruhiko Kuroda says the BOJ should ease until it reaches 2 percent inflation and former BOJ Deputy Governor Kazumasa Iwata has urged more expansive easing, Toshiro Muto warned of the dangers of prolonged loose policy when he was deputy governor five years ago.

The government should unveil its nominations for the new BOJ leadership team by the end of February, the ruling Liberal Democratic Party said last month. While Abe’s coalition has a majority in the lower house, it will need help from smaller opposition parties in the upper house for its choices to be confirmed.”


(emphasis added)

As far as we are aware, of the gentlemen listed above, Kazumasa Itawa is the one most likely to pursue an extensive inflationary agenda, including large purchases of foreign debt with the aim of weakening the yen. So we will know by the end of February what to expect from the BoJ in terms of future policy. If Itawa gets the job, then the easing measures planned for 2014 will likely be pulled forward into 2013.

In the meantime, below is the latest wave count update for the yen by our friend PN. According to this view, the yen appears to have bottomed for now. If this is correct, then a correction in 'risk assets' cannot be far away either.




PN's latest wave count update on the Japanese yen. The comments in the chart are his – click for better resolution.



Addendum: Dimitri Speck's Seasonal Charts

For readers who are not familiar with them, we wanted to point out that we have added a link to our blog-roll that points Mr. Dimitri Speck's German language site on seasonal charts ("Dimitri Speck's Seasonal Charts"). While the site is in German, this obviously doesn't matter in the context of charts.  We believe such seasonal charts are very useful, not only in the normal course of trading, but also – perhaps especially –  in those situations when a market diverges from its normal seasonal patterns, as that is often a strong warning sign of an impending major trend change (as an example recall the action in the stock market in late 2007/early 2008).



Charts by: BarCharts, PN



Dear Readers!

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