The Coming Acceptance Of Japanese Negative Interest Rates As Self Evident

by: Adam Whitehead


New replacement governors are slowly giving BOJ Governor Kuroda the free hand that he needs for radical policy action.

The BOJ and the banking sector have compromised over the acceptance and passing on of negative interest rates.

In the absence of G20's blessing Kuroda can only weaken the yen at the margins of effectiveness.

Acceptance of the BOJ's next easing move as self-evident requires the mitigating circumstances and precedent of a shock strengthening of the yen.

The surprise at the BOJ's unchanged policy decision provides the catalyst for the BOJ's next radical easing step.

(Source: Bloomberg)

Having failed to get the blessing of G20 for a unilateral move to weaken the yen, at the IMF summit in Washington, the BOJ was boxed into a corner. In order to help it get out of this corner and to understand where it has gone wrong in framing market expectations of negative interest rates to weaken the yen, the BOJ recruited a new board member. New recruit Takako Masai has a background in FX and capital markets. Whilst not an overt reflationist, she has said nice things about negative interest rates in the past. She is therefore expected to be a consensus follower rather than an interventionist. Governor Kuroda just needs to create the consensus for her to blindly follow therefore.

Her input will be invaluable for the BOJ to understand the behavior of the markets in relation to its policy moves. She may also have the requisite respect of market professionals to be able to influence their perceptions. Evidently, the BOJ has understood that it needs to change its personnel and rhetoric to conform with market conventions; rather than to have career bureaucrats try to force their desires onto suspicious speculators.

The appointment of Ms Masai is symbolic of the conflict and change being engineered at the BOJ. She replaces Koji Ishida, who was widely viewed as a proxy voter for the powerful Sumitomo Banking group. With the departure of Sayuri Shirai, the number of governors who voted no to negative interest rates has now been whittled away from four to two. Kuroda is making steady progress towards getting the consensus group that he desires. He needs more time though.

To get his consensus, it is becoming very clear that he is having to remove the influence of the Japanese banking majors within the board. These banks have been the biggest impediment to and critics of negative interest rates. With its dwindling insider influence, the banking cartel has become more vociferous in its public criticism and resistance to Kuroda. MUFG President Nobuyuki Hirano recently warned the BOJ not to push interest rates further into negative territory.

Kuroda may therefore find that his growing consensus within the BOJ meets with an equal and opposite consensus from Japan's major banks. Said banks are the nation's source of credit and interest rate savings products. The conflict will therefore translate into a headwind for the real economy, that will undermine Abenomics in general. It may be that Abe and Kuroda desire to ultimately replace the influence of the big banks with another credit transmission vehicle. As yet there is no alternative, so they need to step very carefully.

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(Source: Bloomberg)

The evidence suggests that the threats from the big banks have worked; and that a compromise for all concerned has been reached. Smoke signals emerged which suggest that the BOJ will now lend to the banks at negative interest rates rather than at zero. The BOJ will therefore pay the banks not to charge their depositors negative interest rates. The banks don't really care about their depositors, all they care about are their margins and their share prices. If the BOJ wishes to subsidize the banks, then so be it.

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(Source: Bloomberg)

From the BOJ's perspective, this bribe to the banks is worth it because negative interest rates can now be passed directly through to the economy via the existing banking system. The BOJ can therefore show that its decision to use negative interest rates is working. In theory the crowded yen long speculators will then get panicked into selling; so that price discovery appears to confirm that the BOJ has been vindicated on its application of negative interest rates.

The symbiotic success of the BOJ and the big banks in passing through negative interest rates will be short-lived however. The stoic Japanese people have shown themselves to be capable of dealing with this new environment. They will simply decamp to physical cash and precious metals. The BOJ will then be faced with the next hurdle of nudging them out of physical cash. Presumably this will be done by simply printing more of it, so that it has no intrinsic value.

Despite being denied a unilateral move to weaken the yen, Mr. Kuroda was given the room to verbally squeeze the crowded yen long positions. According to his recollection, he faced down his G20 opposite numbers and told them that he would unilaterally ease if his inflation target was threatened. Apparently this show of his virility was enough to scare the G20 delegates into accepting his aggressive stance. Kuroda was therefore allowed to return home to Japan without the all-important loss of face. When he failed to follow through on his threats at the ensuing BOJ meeting, this matter was already forgotten.

G20 does not desire any volatility in currencies, that may undermine the big strategic move for the Fed to normalize whilst the ECB continues to ease. Kuroda therefore has room to jawbone on the margins of this bigger picture. He did this with limited effect, when he gave an interview in which he said the strengthening yen would weaken inflation by such a degree that he would be forced to unilaterally weaken the currency. This was enough to squeeze some of the weaker hands out of the crowded long yen trade, and send it back to pre-IMF meeting levels. In return he paid his G20 colleagues back by stating that "Helicopter Money" is currently not on the agenda in Japan; thus accepting the G20 edict not to unilaterally weaken a currency.

Governor Kuroda showed discipline and stuck to the narrowly defined mission to correct the yen back to unchanged pre-IMF meeting levels. After squeezing out the weak yen longs over a period of two days, he then opined that monetary easing is not a promise of a weaker currency and stronger equities. The sell-off in the yen and the rally in Japanese equities swiftly ended. Kuroda has demonstrated to his G20 colleagues that he can be trusted not to exceed the remit that they give him. When it is his turn to weaken the yen, he hopes that they will remember his discipline and indulge him.

Should BOJ newcomer Ms Masai be struggling with her communications, it seems that the Abe regime has a few tricks up its sleeve in relation to framing public opinion. Having failed with its proselytizing for Abenomics, the regime has decided to simply control the press. As Orwell observed, in times of deceit telling the truth becomes a revolutionary act.

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Ex BOJ Deputy Governor Kazumasa Iwata is not the kind of trusted source that the Abe regime wants to censor. In order to prepare the acceptance of negative interest rates as being self-evident, he pushed the debate beyond their utility towards what level they should be at. He suggests negative one per cent. It would seem that negative interest rates in Japan are undergoing Schopenhauer's test of the truth. They have been ridiculed, violently rejected and are now in the process of acceptance.

Like Mr. Kazumasa, former economy minister Yasutoshi Nishimura is a trusted source that the Abe regime would like to be heard. He verbally intervened on the eve of the BOJ policy meeting to prevent a further slide in the yen and to raise expectations for easing at the meeting. According to him, at 110 to the US Dollar the yen is too strong.

Despite the growing self-evident nature of the next BOJ stimulus, there are those in its ranks who remain circumspect about the outcome. These nameless insiders have not seen the reciprocal behavior, from either Japan Inc or the Japanese government, that will sustain the benefits of the easing in the real economy. Both these reluctant respondents seem to take whatever they can get from the BOJ, as if it has inexhaustible resources, but deliver little in return in terms of stimulus or supply side reforms. These disgruntled BOJ members therefore made it clear that they are expecting said reciprocal stimulus and reforms from the government this time round.

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(Source: Bloomberg)

Acceptance of the BOJ as the biggest player in Japanese equities is also rapidly becoming self-evident. The BOJ now holds approximately fifty five percent of the ETF product in the market place. Through its equity ETF purchases, the BOJ is currently in the top ten of holders and moving up the table fast. It is ironic that Japan inc fails to create jobs, boost investment and raise salaries whilst the BOJ enables this and rewards management with higher share prices; and Governor Kuroda simultaneously pleads with CEO's to do so.

He talks like an activist investor yet behaves like an extremely passive one. Kuroda's perverse solution to deflation thereby creates the incentive to maintain it. Japanese share valuations are therefore not reflective of the true growth situation, but are in fact commanding the BOJ's liquidity premium for the lack of it. Japanese equities are therefore a barometer of BOJ policy rather than an accurate indicator of the return on shareholder equity.

On the eve of the latest BOJ policy meeting, Abe's adviser Etsuro Honda increased the pressure for some action. In his opinion, the BOJ was in a perfect position to begin its expansion of the QQE process. Former BOJ governor Nobuyuki Nakahara an original 2001 QE architect swiftly retorted, in order to take the pressure off. In his opinion, the BOJ should prudently wait and assess the fallout from its actions on negative interest rates in January before forging ahead.

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(Source: Bloomberg)

Ultimately on announcement day Governor Kuroda chose to revert back to his old cat and mouse games with the markets. By disappointing the high level of expectations, with no change in policy, he created the negative market reaction and sentiment that demands he act aggressively. The expectation and hence the underwhelming was made more intense by the announcement that inflation had fallen to a post-2013 low before the interest rate decision was communicated. Since 2013 was the launch pad for the recent monetary expansion, the swift conclusion was drawn that this has failed; so that now something even more radical is required.

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(Source: Bloomberg)

The level of drama was then heightened with economic reports which confirmed this policy failure and the need for the BOJ to think out of the box. Cash continues to compound and lay idle in deposits. The deal between the BOJ and the banks not to pass on negative rates to depositors (discussed above) will only exacerbate this compounding of deposits. The BOJ is therefore making its case to make an indirect assault on this cash. In the next radical step, even a move to make negative interest rates even more so will now be viewed as self-evident. In fact, they will be accepted as so commonplace that something even more radical will be demanded by speculators.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.