Peter Pan And The 'Magic People': Do You Believe In A Weak Yen?

| About: CurrencyShares Japanese (FXY)


Bank of Japan governor Haruhiko Kuroda is on an epic quest to rescue the Japanese from deflation.

He has single-handedly cornered the Japanese government bond market and the market for Japanese ETFs.

Betting on a weak yen requires faith in monetary magicians.

Let's talk about Japan for a second.

Japan is a magical place where it's perfectly acceptable to have a public debt pile that's measured in quadrillions, where quintuple-dip recessions actually exist, and where Paul Krugman is looked upon with the reverence normally reserved for saints. In fact, it was just Friday when Prime Minister Shinzo Abe deferred a consumption tax hike for the second time, presumably inspired (also for the second time) by Krugman.

Over the past several years, the country has become the poster child for monetary policy gone wild. In the process, Bank of Japan governor Haruhiko Kuroda has earned a reputation for being a man whose willingness to push the limits of mutant Keynesianism knows absolutely no bounds. So committed to the cause is Kuroda that he once said the following about himself and his ilk: "I trust that many of you are familiar with the story of Peter Pan, in which it says, 'the moment you doubt whether you can fly, you cease forever to be able to do it.'" The implication was that as long as the market believes in central banks' ability to keep things going, everything will be fine.

Kuroda has employed every tool in the unconventional policy toolbox in his epic quest to drag Japan kicking and screaming out of the deflationary doldrums. Bond buying? Check. Stock purchases? Check. Negative rates? Check.

This is a man who has now single-handedly cornered the Japanese government bond market and the market for Japanese ETFs. Consider this: Kuroda is monetizing the entirety of gross JGB issuance, he's a top 10 shareholder in 90% of the Nikkei, and all told, he owns 55% of the Japanese ETF market.

He's a veritable marvel of central planning.

There's only one problem: nothing he's done has worked. Sure, he's levitated the Nikkei, but when it comes to growth and inflation, he's running (actually no, given the scope of BoJ easing it's probably more appropriate to say that Kuroda is sprinting) in place. Recall the chart I presented earlier this week which shows that despite the BoJ's valiant (not to mention hilarious) effort to pretend as though deflation has been stamped out by creating new measures of inflation that simply don't include items for which prices are falling, Kuroda still hasn't hit the mark. Have a look at the following chart which shows the evolution of economists' forecast for the core CPI:

(Chart: Goldman)

But that hasn't stopped Kuroda from being optimistic. And it most assuredly hasn't left him shy when it comes to talking about his battle against disinflation. The man is a quote machine. Try this one night: at around 8 p.m. ET, pour yourself a drink, sit down at your desk, and check your terminal for Kuroda quotes. Then prepare to laugh yourself sick. Here's a sample from Wednesday evening:

"Low rates continuing for long time may cause problems."

"Too soon to discuss details of an exit strategy."

"Desirable for currency to move in stable manner."

And the best one of all:

"Don't think 'Kuroda bazooka' is right description."

I say all of this to set up the following soundbite, also from Wednesday: "Any BoJ easing could use any of the three methods." By "methods," Kuroda is referring to the "three-arrow monetary easing" strategy (the Japanese like to describe policy in terms of "arrows") that encompasses quantitative easing, qualitative easing, and negative rates.

What caught my eye about this particular quote is that he's actually lying. Further BoJ easing cannot use any of the three methods. There are no more JGBs to buy. Consider the following rather straightforward assessment from Barclays:

Having acquired colossal volumes of JGBs at a pace exceeding new JGB issuance, the bank will sooner or later face a serious risk of a shortage of JGBs eligible for its purchasing scheme, leaving its operations undersubscribed. Our yen interest rate strategy team believes this situation will materialize in 2H 2016 based on an analysis of JGB supply/demand, but we believe it could occur even earlier given market anticipation of a JGB shortfall and rising demand for JGBs, in part, as collateral in connection with tighter regulations. As a result, the bank may find itself unable to supply base money through its JGB purchasing, compelling it to abandon at least in part its target of JPY80trn annual increase in outstanding base money supply. The markets see such unintended tapering as a clear and present danger, as symbolized by the overreaction to the unexpected reduction in the bank's JGB purchasing volume due to technical factors in its recent monetary operations.

(Chart: Barclays)

What Barclays is presumably referring to when they mention "technical factors in recent monetary operations," are wild swings in POMO bid-to-covers and at least one instance of a tripped circuit breaker as the market tried to interpret and react to the level of participation (or lack thereof) after the fact.

Anyway, what this means is that if Kuroda wants to ease further, he's going to have to buy more ETFs or take rates further into negative territory.

As it stands, the BoJ is buying JPY3 trillion in ETFs each year, plus an additional JPY300 billion in ETFs that don't even exist yet. That's right: Kuroda has promised to buy make-believe ETFs. The idea is to "encourage" companies to spend on capex and human capital by buying those companies' shares. The problem is there are currently no such dedicated ETFs (or at least a miniscule number of them).

As for a further push into negative territory for policy rates, well, Kuroda's got a quote (or four) for that. These are also from Wednesday evening:

"Technically we can go as low as the ECB."

"We can still ease our monetary policy substantially if we consider it necessary."

"We are absolutely on the right track on inflation."

By "right track," I suppose he means "still in deflation."

Kuroda also noted that he'd need to "ask himself what is necessary and what is appropriate." Soon enough we'll discover what answer he gave himself, but the problem at this juncture is that the last time the BoJ eased (at the end of January), everything moved in the wrong direction. The yen appreciated and the Nikkei slid. Apparently, the market viewed the move into NIRP as Kuroda scrambling out of the pocket with no time left on the clock and launching a monetary Hail Mary towards the inflationary end zone.

The pass was incomplete.

At a loss and not wanting to be the first guy to break the Shanghai Accord (i.e. the "secret" weak dollar pact) Kuroda sat on his hands last month and cringed as the yen moved towards 100. Finally, Aso stepped in and promised to intervene in the FX market if things got too far out of hand.

The point here (well, other than to entertain) is that betting on Kuroda to bring about sustained yen (NYSEARCA:FXY) weakness with further monetary accommodation may be a decidedly poor gamble. Intervention by the finance ministry or no intervention, what transpired in the wake of the BoJ's move into NIRP seems to suggest the market is going to test Japanese policy makers. There's blood in the water here and with no more JGBs to buy and an ETF book that already accounts for more than half of the entire market, it's not clear how much further the envelope can be pushed - even when it's Kuroda doing the pushing.

Then again, the ECB's Vitas Vasiliauskas (who is also Lithuania's central bank chief) wants you to know that Kuroda is correct to compare central bankers to the flying, green leotard donning, protagonist from a fairy tale. Here's what Vasiliauskas told Bloomberg earlier this week:

"We are magic people. Each time we take something and give to the markets - a rabbit out of the hat."

I know at least one Nobel Prize winning economist who would agree.

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.