BOJ’s policy calls are being made in Washington and Beijing

TOKYO – Though governor Kazuo Ueda announced the news last Friday, the Bank of Japan’s decision to leave interest rates unchanged was really made in Washington. Two days earlier, US Federal Reserve chairman Jerome Powell disappointed many by suggesting the harshest US tightening cycle in 30 years isn’t over. That news, in many ways, left Ueda’s team at the BOJ with nowhere to go – and standing pat today. Virtually everyone agrees the BOJ must begin normalizing interest rates as soon as possible. The 23 years of quantitative easing (QE) have warped credit markets and deadened the “animal spirits” needed to reinvigorate Japanese innovation and competitiveness. But it’s hard to imagine that process beginning with the threat of more Fed rate increases hovering over Japan Inc. And while neither Ueda nor Prime Minister Fumio Kishida is saying so publicly, both are happy to see the yen weaken further. The yen’s 12.9% drop this year puts it on the cusp of 150 to the US dollar. A weaker exchange rate makes exports cheaper and helps Tokyo offset headwinds from US trade sanctions. Though aimed at China, President Joe Biden’s tech policies are causing considerable pain for Japan and South Korea, too. Even as Biden works to pull Japan and Korea further into America’s orbit, the US-China trade war is crimping the ability of neighbors to boost exports, particularly manufacturers of high-tech equipment. Exports of materials that normally would be purchased by Chinese factories remain largely in limbo. Korea, for example, had been pinning hopes on the post-Covid rebound by China, its top trade partner. Weak demand for semiconductors contributed to an 8.4% drop in South Korean exports year on year in August, the 11th consecutive monthly decline. Being caught between Washington and Beijing creates a “two-sided reality” causing “unprecedented pressure” as the “US-China rivalry intensifies and spills over to affect trade and technology policy,” explains Chung Min Lee, senior fellow at the Carnegie Endowment for International Peace. For Kishida’s government, a weaker yuan versus the dollar also may be preferable. Bringing the yen and yuan into closer alignment might help both Japan and China. Japan needs to export more goods to the West. A weaker yuan could stabilize China’s economy, bringing more business Japan’s way. Fumio Kishida, the Japanese prime minister. Image: Screengrab/ABC News Meanwhile, Ueda is left with a slowing domestic economy and an increasingly shaky global scene as China slows and fallout from 11 Fed rate hikes in 17 months clouds the US outlook. Japanese “domestic demand is struggling, and employment conditions are softening,” says economist Stefan Angrick at Moody’s Analytics. And “wage gains continue to trail inflation.” Inflation has complicated Ueda’s decision-making since he arrived on the job in April. Going into the BOJ’s two-day policy meeting this week, there was a strong inclination to announce a formal victory over deflation. Naoki Tamura, a hawkish voice on the BOJ’s nine-member policy board, has been arguing that Tokyo’s 2% target “has come into view.” Yet it’s a Pyrrhic victory. The big question on Ueda’s mind is being confident he has “gathered sufficient evidence of a virtuous wage-price cycle,” says currency strategist Carol Kong at Commonwealth Bank of Australia. Japanese consumer prices are rising at a 3.1% rate year on year. Though down from a 4.2% rate in January, a 41-year high, inflation has now increased for 17 consecutive months. Trouble is, it’s the “bad” kind – imported thanks to elevated energy and food prices, not organic pressures at home. Over the last two-plus decades of QE – and especially the last 10 years – ultra-loose BOJ policies sought to generate “demand pull” inflation as strong consumption drove companies to raise prices and fatten paychecks. Instead, Japan’s inflation is of the “cost push” variety. It owes far more to Vladimir Putin’s Ukraine invasion than BOJ easing. This is exactly the opposite of what Ueda’s predecessor Haruhiko Kuroda intended between 2013 and 2023. Kuroda swelled the BOJ’s balance sheet to the point where it topped Japan’s US$5 trillion economy. Sign up for one of our free newsletters Then-Bank of Japan Governor Haruhiko Kuroda in 2017. Photo: Asia Times files / Reuters / Kim Kyung-Hoon At the same time, surveys show that Japan’s 126-million-population economy isn’t enjoying this “victory” over inflation. Prices are rising faster than wages, an unwelcome dynamic that’s hurting household confidence. This tension explains why Kishida’s approval numbers are mired in the low 40s, at best. Speaking at the United Nations General Assembly this week, Kishida described the economy as “currently still not fully stable.” Next week, he said, Tokyo will unveil “measures to counter inflation” and “social measures to counter declining population.” It’s a rough political environment for Ueda to navigate. Thoug

BOJ’s policy calls are being made in Washington and Beijing

TOKYO – Though governor Kazuo Ueda announced the news last Friday, the Bank of Japan’s decision to leave interest rates unchanged was really made in Washington.

Two days earlier, US Federal Reserve chairman Jerome Powell disappointed many by suggesting the harshest US tightening cycle in 30 years isn’t over. That news, in many ways, left Ueda’s team at the BOJ with nowhere to go – and standing pat today.

Virtually everyone agrees the BOJ must begin normalizing interest rates as soon as possible. The 23 years of quantitative easing (QE) have warped credit markets and deadened the “animal spirits” needed to reinvigorate Japanese innovation and competitiveness.

But it’s hard to imagine that process beginning with the threat of more Fed rate increases hovering over Japan Inc. And while neither Ueda nor Prime Minister Fumio Kishida is saying so publicly, both are happy to see the yen weaken further.

The yen’s 12.9% drop this year puts it on the cusp of 150 to the US dollar. A weaker exchange rate makes exports cheaper and helps Tokyo offset headwinds from US trade sanctions. Though aimed at China, President Joe Biden’s tech policies are causing considerable pain for Japan and South Korea, too.

Even as Biden works to pull Japan and Korea further into America’s orbit, the US-China trade war is crimping the ability of neighbors to boost exports, particularly manufacturers of high-tech equipment. Exports of materials that normally would be purchased by Chinese factories remain largely in limbo.

Korea, for example, had been pinning hopes on the post-Covid rebound by China, its top trade partner. Weak demand for semiconductors contributed to an 8.4% drop in South Korean exports year on year in August, the 11th consecutive monthly decline.

Being caught between Washington and Beijing creates a “two-sided reality” causing “unprecedented pressure” as the “US-China rivalry intensifies and spills over to affect trade and technology policy,” explains Chung Min Lee, senior fellow at the Carnegie Endowment for International Peace.

For Kishida’s government, a weaker yuan versus the dollar also may be preferable. Bringing the yen and yuan into closer alignment might help both Japan and China. Japan needs to export more goods to the West. A weaker yuan could stabilize China’s economy, bringing more business Japan’s way.

Fumio Kishida, the Japanese prime minister. Image: Screengrab/ABC News

Meanwhile, Ueda is left with a slowing domestic economy and an increasingly shaky global scene as China slows and fallout from 11 Fed rate hikes in 17 months clouds the US outlook.

Japanese “domestic demand is struggling, and employment conditions are softening,” says economist Stefan Angrick at Moody’s Analytics. And “wage gains continue to trail inflation.”

Inflation has complicated Ueda’s decision-making since he arrived on the job in April. Going into the BOJ’s two-day policy meeting this week, there was a strong inclination to announce a formal victory over deflation.

Naoki Tamura, a hawkish voice on the BOJ’s nine-member policy board, has been arguing that Tokyo’s 2% target “has come into view.”

Yet it’s a Pyrrhic victory. The big question on Ueda’s mind is being confident he has “gathered sufficient evidence of a virtuous wage-price cycle,” says currency strategist Carol Kong at Commonwealth Bank of Australia.

Japanese consumer prices are rising at a 3.1% rate year on year. Though down from a 4.2% rate in January, a 41-year high, inflation has now increased for 17 consecutive months.

Trouble is, it’s the “bad” kind – imported thanks to elevated energy and food prices, not organic pressures at home.

Over the last two-plus decades of QE – and especially the last 10 years – ultra-loose BOJ policies sought to generate “demand pull” inflation as strong consumption drove companies to raise prices and fatten paychecks.

Instead, Japan’s inflation is of the “cost push” variety. It owes far more to Vladimir Putin’s Ukraine invasion than BOJ easing. This is exactly the opposite of what Ueda’s predecessor Haruhiko Kuroda intended between 2013 and 2023. Kuroda swelled the BOJ’s balance sheet to the point where it topped Japan’s US$5 trillion economy.

Bank of Japan (BoJ) Governor Haruhiko Kuroda is pictured at the bank's headquarters in Tokyo on April 27, 2017. Photo: Asia Times files / Reuters / Kim Kyung-Hoon
Then-Bank of Japan Governor Haruhiko Kuroda in 2017. Photo: Asia Times files / Reuters / Kim Kyung-Hoon

At the same time, surveys show that Japan’s 126-million-population economy isn’t enjoying this “victory” over inflation. Prices are rising faster than wages, an unwelcome dynamic that’s hurting household confidence.

This tension explains why Kishida’s approval numbers are mired in the low 40s, at best. Speaking at the United Nations General Assembly this week, Kishida described the economy as “currently still not fully stable.” Next week, he said, Tokyo will unveil “measures to counter inflation” and “social measures to counter declining population.”

It’s a rough political environment for Ueda to navigate. Though the BOJ is technically independent, the Tokyo establishment tends to push back hard on any step by the BOJ deemed unhelpful to the government’s priorities.

At the moment, that includes the stability of Tokyo stocks, which rose to 30-year highs in recent months. Even Warren Buffett’s Berkshire Hathaway has been upping its bets on Japan Inc, putting the nation’s equity bourses in global headlines for all the right reasons.

This narrative explains why “the BOJ isn’t going to slow the economy too much or slow things too quickly,” says strategist John Vail at Nikko Asset Management Co.

After all, Kuroda had ample political capital to begin normalizing rates as his decade at the helm drew to a close. Kuroda’s “bazooka” blasts were widely credited for record corporate profits in the mid-to-late 2010s. In 2013 alone, the Nikkei Stock Average surged 57%.

In late December, the Kuroda BOJ tested the financial waters by letting 10-year bond yields rise as high as 0.5%. Global markets quaked as the yen skyrocketed. The BOJ spent the last days of 2022 making huge unscheduled bond purchases to tame markets – and to communicate that QE remains.

Ueda tried his own rate experiment in late July when the BOJ suggested 10-year yields could rise as high as 1%. Again, global markets shuddered.

Fears of surging Japanese government bond yields quickly rippled through global credit markets. For one thing, 23 years of zero to negative rates morphed Japan into the globe’s premier creditor nation. Those funds are then invested in higher-yielding assets from Brazil to South Africa to Indonesia, what punters call the “yen carry trade.” As such, sharp yen moves tend to slam markets everywhere.

Ultra-low interest rates prompted yield-hungry Japanese investors to become the biggest foreign holders of US government debt. Also, Japan’s government is the top holder of US Treasury securities among sovereign investors.

Hence the extreme focus on moves Powell makes in Washington. This week, the Fed said its economists think it won’t be until 2026 that average annual inflation falls back to 2%.

As Powell put it: “We’re coming into this with an economy that appears to have significant momentum. But we do have a couple risks.”

Federal Reserve chairman Jerome Powell testifies during the Senate Banking Committee hearing titled ‘The Semiannual Monetary Policy Report to the Congress’ on March 3, 2022. Photo: Tom Williams / Pool

In the short term, the risks include a potential government shutdown as US lawmakers bicker over spending cuts and additional funding for Ukraine. A strike by United Auto Workers members could lower national growth and intensify inflation pressures.

In the longer run, Powell’s team must decide what it’s willing to do to achieve that 2%. Because, post-Covid-19, most US inflation is coming from the supply side, high prices are best addressed by Biden’s White House acting to increase productivity and innovation.

Yet the Fed is also making up for past mistakes and lost time. Powell’s first big error was bowing to then-president Donald Trump, who demanded lower US rates. So in 2019, the Fed added monetary stimulus that the US economy didn’t need.

In 2021, Powell erred again by arguing inflation was “transitory.” When it became clear that it wasn’t, the Fed scrambled to play catch up.

Now, the Fed is at a fork in the road as it endeavors to get inflation down to 2% from around 3% today, says economist Mohamed El-Erian at Allianz. “The Fed at the end of the year is going to have a choice: You live with 3% or higher inflation, or you crush the economy,” he says.

El-Erian worries, too, that fallout from the Fed’s tightening cycle has only just begun. He warns that higher rates will cause a world of pain for a wide swath of corporations come 2024.

“If you look at high yield, if you look at commercial real estate, there’s massive refinancing needs next year – massive,” El-Erian tells Bloomberg. “So that’s the point of pain which starts to happen.”

El-Erian thinks “there are things that have to be refinanced in this economy that cannot be refinanced in an orderly fashion at these rates.” And that “some people will tell you there’s lots of distressed credit funds with lots of money waiting to come in. We’re going to see a game of chicken between the two.”

Fidelity International also worries that pent-up debt refinancing struggles in 2024 could tip the US into recession.

For Ueda’s team in Tokyo, US politics are an added wild card. In August, Fitch Ratings stripped the US of AAA status, citing swelling debt and a “steady deterioration in standards of governance.”

This latter reference was to Republicans in Congress playing games with raising the US debt limit. A similar tactic saw S&P Global Ratings downgrade Washington in 2011. And now Fitch.

The specter of surging US rates is causing visibility problems for Ueda’s team. If the BOJ sticks with QE as US yields ratchet higher, new financial stress points are sure to emerge. That might force the BOJ to hoard even more Japanese Government Bonds and stocks via exchange-traded funds.

Yet if the Ueda BOJ pivots toward tapering, opening a Pandora’s box that Kuroda wouldn’t, the yen could surge. That might dim Japanese growth prospects and send Nikkei stocks sharply lower.

This month, Ueda hinted that he’s eyeing a way into that box. He told the Yomiuri newspaper that the BOJ’s focus is on “a quiet exit” that doesn’t slam markets. “It’s not impossible that we will have enough by the end of the year to anticipate” wage increases going forward, he said.

For now, though, Ueda says “there are some things we can’t see.” That includes events in the US, which will arguably have more say on when and how the BOJ proceeds than Ueda here in Tokyo.