Kuroda to the rescue

I think we can be pretty clear on that one… Jackson Hole gave us nothing. Despite this little bit of a dollar strength based on some wishful thinking of a few pundits that the Fed will finally raise rates this year we have been presented with more of the same market lull this week. Equities are moving sideways, bonds are equally stuck in their mini range, and gold doesn’t know what to do.

To be fair, last Friday’s event was probably one of the most horrible in recent history among any attempts of the Fed to guide markets. You only had to watch 3-4 interviews given by different members and you knew what the real problem was. It literally sounded like each one of them was doing their own thing, looking at parameters of their choosing and excluding and including certain policy objective at will.

Janet Yellen I guess was supposed to have the last word with her address on Friday evening, in what one could only assume to be a summary of the latest Fed stance. While it was more of the same of her usual lingo, she sounded relatively dovish in essence and markets took it at face value, i.e. bonds rallied as the dollar dipped in an immediate reaction to her speech.

Little did we know that her vice chair Stanley Fischer rushed to give an interview right after Yellen’s address, only to sound lots more hawkish than she did. Markets reversed course, bonds dumped and the dollar spiked. I don’t know about you… but I was wondering all weekend what the purpose of this charade might have been. I thought the Fed was in the business of guiding markets, not disinforming and confusing everybody.

Anyway, we are where we are, and we can only look at the next potential event of a monetary policy nature that could provide the world with some direction. And that event is without a doubt the upcoming Bank of Japan meeting on September 20-21. Haruhiku Kuroda has been fairly quiet throughout the summer, but he did manage to slip in a comment here and there lately, most recently at the very Jackson Hole meeting.

And if you can believe him, he is ready to ease further. What exactly he and his colleagues will do, he has obviously not been elaborating on. His reference is limited to an “extremely powerful policy scheme between quantitative easing and negative rates”… so basic central banker speak, as in everything and nothing. But seriously, what can he or is he likely to do?

Firstly, he’s hinted at the negative rate scenario, so he is likely to not do anything stupid there except probably lead us lower into negative territory. In the end, this is all about weakening the Yen again to salvage the export economy and get some desired inflation going. That this has been and will be mission impossible by way of Japan’s disastrous demographics is besides the point. The authorities will do whatever they think they must.

Secondly, there are no suspicions that the current level of QE will be tampered with, which means that at around 800 billion dollar equivalent asset purchases per year the BoJ will be running out of JGBs to buy in a year or two. Kuroda”s “ample space for additional easing” has other asset classes in sight though. Not only is he buying the stock market like a mad-man, making him the dominant shareholder in many of the blue chip companies…

… there is also still the issue of helicopter money. Most likely, it will be put in practice in a similar way as it’s to be done in Canada, i.e. the BoJ will purchase infrastructure and other corporate bonds directly or finance certain industries’ R&D bills for example. There is obviously a legal framework around what the BoJ can and cannot do, but we have seen that being circumvented or outright broken in other currency areas such as the eurozone.

All these measures naturally incur costs. Pushing rates even deeper into the red while compromising the JGB market’s existence will eventually kill off the banks, so Kuroda cannot do both at full force without risking a crash in bank stocks and defeating the whole purpose of the exercise. Infra bonds are a good idea as the newly printed money enters the economy directly, but how many more bridges to nowhere can Japan absorb?

Stopping short of helicopter money in its true sense, i.e. literally handing cash out to the population, there may be something else the BoJ is mulling over that is entirely unprecedented and has started to make the rounds among some of the punditry lately. Now that the BoJ has quasi-nationalised its own bond market as well as large parts of the stock market, it may resort to the only and probably most effective tool left to debase the Yen.

What if the BoJ started to buy foreign government bonds, much like the Japanese life and pension companies have vacuumed up the US investment grade corporate bond market in recent months? The significant benefit of buying foreign bonds would be its mechanism to weaken the Yen. As this would be done by the BoJ, it would circumvent the US allegation of the Japanese government to be deemed a currency manipulator.

There are obviously issues with such a strategy. It would formally not be the government but the BoJ that manipulates the currency. Whether the BoJ wants to slip into that role on one hand, or whether one gets away with this kind of window dressing on the other, is a legitimate question. The other issue is whether the BoJ could just go ahead and start buying Treasuries at will without coordinating with the US government and the Fed.

So there is still a lot to be overcome, but conceptually this strategy makes a lot of sense with regards to what Japan needs to achieve. In any case, the BoJ will have to come up with something that is convincing on September 21. The stakes are too high. It appears the market is gaining confidence that Kuroda will not disappoint this time around, as the Yen has shown signs of weakness lately and eclipsed the 103 yesterday.

And yes, in case you were wondering, Expertise Asia’s call for the Yen to eventually hit 150 stands. Just don’t ask how much longer it will take 😉 I am positioned having bought long-dated out-of-the-money options.