The BOJ Briefly Goes Negative And Then Permanently

Includes: FXY
by: Adam Whitehead


The reason for BOJ Governor Kuroda's disappearance was his participation in a market test of negative interest rates.

The market did not respond well to the trial of negative interest rates.

The only significant impact of the negative interest rate announcement is the surprise value.

Negative interest rates are a further tax on savers that will increase their deflationary liquidity preference.

The breakdown of Say's Law signals that central banks have lost their credibility in achieving their inflation targets.

The last report observed that the strengthening Yen and falling equity market would prompt some form of reaction by the BOJ. The disappearance of Governor Kuroda was also observed, although there was little speculation or confirmation of what he was up to. After the latest policy move to negative interest rates, the reason for his disappearance has become clear. The Governor and his team were doing a trial negative interest rate war gaming session.

Whilst Governor Kuroda remained holed up in silence, the BOJ tested out its next policy move. This move was neither heralded nor opined upon by the Governor or any of his colleagues at the time. It should therefore be seen as a test of market perceptions. The BOJ was trying to see what it can get away with; and thereby frame market perceptions to accept more of what it can get away with.

The tested policy move involved executing QQE at negative yields for the first time. The market feedback was not what the BOJ wanted to see. Even though the Yen and Japanese equities were allegedly technically oversold, they then sold off even more on the BOJ action. This could just be a case of bad timing. It could also be viewed as trying to paint the tape and the charts to create the picture of a technical bottom.

Without any fanfare from the BOJ the market reaction was negative. Negative interest rates as a policy tool are therefore dead on arrival. This was confirmed by Governor Kuroda himself, when he reported back on his observations of the unofficial trial run. Ostensibly he was not positive about what he saw and suggested that the BOJ would not be pursuing negative interest rate policy.

He chose not to discuss the BOJ's own abortive trial run earlier in the week, as if it had never happened. Instead he used the Fed's own experience as his cover for retreat ;when he said that "there are pros and cons of adopting negative interest rates ... the Federal Reserve didn't adopt negative interest rates and yet, its policy succeeded in stimulating the U.S. economy".

The inference was that the BOJ would not be following negative interest rate policy either. The sublime message was that the BOJ would be adopting negative interest rates; and that it was choosing to maximize the impact by appearing to catch the markets off guard. This is exactly what happened, when the announcement was made at the last BOJ meeting. Those who saw the trial run, know that it failed. Its only success was is its alleged surprise value. Those who have been surprised have been buying Japanese equities and shorting Yen, in the hope that a major new trend is developing. Those who saw the abortive trial run will fade this market reaction. It was a knee jerk reaction, brought about by the panic and market volatility in the New Year.


The outcome has already been predicted by a research note from Reiko Tokukatsu, in the form of a recent bestseller. Evidently Mr. Market understands that negative interest rates are a form of wealth confiscation from lender to borrower. Whilst ostensibly being a bad thing for the lenders, it is actually a good thing for a government that is doing the confiscating. Using the value of the currency as a barometer of the health of the government, the currency should strengthen to reflect an improvement in fiscal position. This is exactly what happened to the Yen.

As speculation mounted about what the missing BOJ Governor was up to, subtle messages on his intentions and capabilities came in from his trusted former colleagues. Taketoshi Ito, a former colleague of Governor Kuroda's at the Ministry of Finance, is one such source. According to Ito, the BOJ can live with the pain of a stronger Yen until it hits 110 versus the US Dollar and/or there is a significant fall in inflation.

This view was echoed by "Mr. Yen" himself, Eisuke Sakakibara. In his view, given the global uncertainty, the new range for Dollar-Yen is 110 to 115. Currency speculators have therefore been invited to drive the Dollar-Yen to 110; at which point all bets are off on its direction and bets should go all-in on another expansion of QQE.

Governor Kuroda was finally forced to break his self-imposed silence, in response to questioning from a lawmaker that put him on the spot about what he intended to do. Governor Kuroda made no reference to the new negative interest rate strategy; which immediately added to its lack of credibility and authenticity. He further undermined this move by replying to his interlocutor that he is not considering further easing "at the moment," even though the overall consumer price level remains far from the central bank's 2% inflation target. Allegedly, "the BOJ is ready to make adjustments on its monetary policy if it sees any changes in the underlying price trend."

Kuroda then confirmed the BOJ's official on hold status, when he addressed a meeting of central bank branch managers. True to form, Kuroda then tried to take markets by surprise when he finally acted; in order to get the maximum impact. His ambivalence and stoicism should therefore be viewed with increasing suspicion. He has in fact become predictable. When he feigns one position, speculators should take the contrary position. This applies to his latest negative interest rate strategy.

Governor Kuroda then verbally intervened as the Yen started to head stronger, after the abortive negative interest rate trial run. This verbal intervention was timed to maximum effect, during a parliamentary session, as the Yen threatened to head on to new highs. According to Kuroda "we will do everything we can" to hit the 2% inflation target and "we have plenty of the policy tools needed to get that done". Given that he had already opined earlier that he was not looking to ease "at the moment", his intervention can only be viewed as an attempt to set the precedent for his negative interest rate move at the ensuring BOJ meeting.

Having stopped the Yen's sharp rally, he then felt able to go back to his default line that the current global volatility will not derail Japan's growth and progress to hitting his inflation target. Then in anticipation of the upcoming BOJ meeting, he felt the need to keep the markets guessing; so he said that inflation expectations were a little on the weak side. His alleged credibility for keeping the markets guessing and his aura of omniscience were therefore being embellished all the time.

In truth Kuroda's very need to feel obliged to micro-manage the markets up and down, evinces an appearance of an innate sense of fear within the BOJ Governor. One of his principle fears was made evident when he suggested that China should apply currency controls in order to stop the slide in the Yuan. Kuroda is clearly worried about China exporting deflation and the implications of this for his attempts to hit the 2% inflation target.

In the peculiar Japanese way of warning by not giving a warning, the Abe administration put the BOJ on notice that it was expected to ease again once the volatility in the markets has subsided. Abe's aide Masahiko Shibayama opined that it was too early for further QQE because the markets are too volatile at present. By saying that it is too early however this made it clear that more is expected "later". This was a signal of a coordinated attempt to put in the bottom for the equity market and top in the Yen, which would give the negative interest rate announcement more credibility.

The forced resignation of disgraced Finance Minister Amari dealt a severe blow to the supporters of Abenomics. With his key ally gone from the Ministry of Finance (MOF), Prime Minister Abe will be looking to the BOJ to do the heavy lifting again. This resignation was timed to the minute; in order to give the BOJ another cue to roll out its negative interest rate strategy.

The BOJ is suffering from the same problem as the Fed and the ECB, namely that they have lost credibility by failing to hit their inflation targets. This was explained in a recent report entitled "Failure Is Not An Option: How The Fed Symmetrically 'Tweaked' Bernanke's Exit Signal". This report said that:

"Under Bernanke's stewardship, the 2% inflation target had been established as a notional point at which unconventional policy could be unwound in a kind of mission accomplished signal. Since then the Fed has been haunted by its failure to hit this 2% target. In a classic case of mendacity the Fed has "tweaked" its 2012 communication to try and hide the fact that it is considering normalizing prematurely before the mission has been accomplished.

In another related case of "symmetry", Mario Draghi also felt that it was incumbent to insist that a failure to hit his 2% target was a failure of the ECB's credibility. Likewise in Japan, Hideo Hayakawa a former BOJ official has opined that the BOJ's failure to hit its 2% inflation target would be a heinous "declaration of defeat".

It would seem that the Fed, BOJ and ECB are doing some painful soul-searching about their inflation targets; or more importantly their failure to hit said targets. Their credibility is on the line; and it is the one thing that central banking is fundamentally based upon. Simply put, they cannot afford to lose their credibility. The Fed has "tweaked" to avoid a loss of credibility. Mario Draghi has come out swinging with a commitment to do more QE to the same end. The BOJ is currently wriggling inside its baggy 2% inflation hair shirt, which it has failed to fill out."

Former BOJ veteran Hideo Hayakawa wrote Kuroda's obituary in the event that he fails to hit his inflation target. According to Hayakawa a failure to adhere to the inflation target, by delaying it or reducing it in light of the bear market in oil prices, will signal an institutional failure of the BOJ. Since oil prices are expected to be lower for longer, Mr Kuroda is now facing posthumous failure. It's getting personal for him.

Markets tend to think in patterns and models. They will now be digesting the pattern of the coordinated attempts by developed central banks to save their credibility. A failure of markets to discount this process, by returning to previous highs, will be a sign that the credibility has been lost permanently. Once central bankers have lost their halos, elected officials will then be expected to do their jobs.

Let's think about how it plays out for the BOJ specifically. Since the banks are paid to take deposits, their deposit bases will fall so that they will not be in a position to lend to anyone except the government. Japanese people won't deposit their money in banks, who are only lending to the government at negative interest rates, especially when they have to pay the banks to lend to the government. The Japanese liquidity preference took a quantum leap. It now remains to be seen if they will spend it or if they will just keep it under the bed.

Just because prices of goods and petrol are falling, it does not necessarily mean that they will go spending with gay abandon. In fact, falling prices are a great incentive to delay non-essential purchases until they have fallen further. If they have had their savings confiscated with negative interest rates, it is highly likely that they will respond by saving through delaying purchases in order to compensate.

(Source: Seeking Alpha - Say What's Breaking Down? - link)

Japan and other developed economies are facing the problem of Say's Law, which was discussed in the report entitled "Say What's Breaking Down?". It was concluded that:

"Investors have given up on risk and consumers have hunkered down to live sensibly off the fruits of their labours and deflation. Nobody is chasing risk asset prices and nobody is chasing prices of goods and services either. This is the sum of all fears for Keynesian economists since as they see it Say's Law is breaking down again. Keynesian minded central bankers will stop at nothing, even the creation of Helicopter Money, in order to prevent this situation from becoming ingrained."

Fire up the chopper Mr Kuroda…… and Janet….. and Mario….. and Mark!

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.