Japan steps through the looking-glass

If you ever had any doubts about the importance of expectations in determining financial asset prices, consider the reaction to Friday's BOJ announcement in comparison with the December ECB policy change.  While the ECB arguably delivered the more substantial easing- cutting the deposit rate 10 bps on the entire stock of excess reserve deposits rather than 20 bps on marginal new ones- the ECB was a disappointment and the BOJ a pleasant surprise in aggregate, thus producing despair and rapture in financial asset pricing, respectively.

As an aside, one does wonder about the point of the whole forward guidance thing when central bankers flat out lie, as Kuroda appeared to do before the Diet and the SNB did before removing the peg last year.   Dissembling or remaining silent about potential policy options is one thing, but saying "we're not gonna do this" a few days before you do it has implications- or at least it should- on your communications strategy moving forwards, as well as those of your central bank colleagues around the world.  Fool me once, shame on you, fool me twice, shame on me.

In any event, the history of Kuroda's shocking monetary announcements (sample size of three: April 4 2013, October 31 2014, and last Friday) suggests that there is more upside to come for the Nikkei and USD/JPY.  That being said, the reaction so far has been a little more muted than the previous two shockers, if only marginally.

However, there are a number of reasons to be skeptical of the move to negative rates.   For one, the policy doesn't touch the existing stock of excess reserve deposits, so it won't exactly incentivize immediate lending.  Insofar as it will push the entire JGB curve lower and possibly flatter, it could be seen as a negative for the financial sector.  Indeed, the whole QQE campaign hasn't exactly been stellar for Japan's banks.  Readers will be shocked to see that as the JGB curve has flattened, the Topix Bank Index has lagged the Nikkei in virtual lockstep.

The notable exception to this was the immediate aftermath of the April 2013 QQE announcement (remember when selling JGBs was a thing?), though the relationship quickly reasserted itself.  In fact, the TSE bank index closed last Friday lower than it did the day after that April '13 policy shocker.

That's a lot of money spent for little impact on the engine room of a modern economy.  While Macro Man isn't naive enough to think that Kuroda's measures are actually designed to work via the real economy (as opposed to impacting financial markets), he does wonder if it's possible to generate 2% inflation when your banks are getting kicked in the groin.  Henceforth it will be worth monitoring the performance of Japanese banks for possible adverse consequences of the new policy.

While it's true that bank lending is up 3.3%, it's also the case that it had turned positive well before Kuroda or even Abe assumed office.   In fact, despite the veritable Mount Fuji of money thrown at Japan's asset markets, the rate of lending growth has barely budged since the onset of hyper-aggressive monetary policy.  But hey, at least they've managed to get Mrs. Watanabe and the pensions to buy stocks and sell yen and multi-year highs (and lows).  What could go wrong?

An obvious answer is that China could choose to devalue its currency again, which would a) leave Japan's TWI not much lower than it was before NIRP, and possibly higher, and b) almost certainly leave Japanese equities lower courtesy of global risk aversion.  That's the funny (and tragic) thing about competitive devaluations and beggar-thy-neighbour policies; no one ever has the last move.

Ironically enough, perhaps Japan's greatest friend in this regard is gaijin hedge fund managers.   By pimping their anti-China bets so aggressively, these chaps could well encourage the Chinese to forestall any exchange rate adjustment so as to thwart the ambitions of "foreign devil" speculators. While the Chinese are selling USD at a furious rate, there are still plenty of FX reserves for the time being....time, that is, to let the foreign devils stew on their negative carry trades for a while.

In the meantime, add Japan to the list of countries that has stepped through the looking glass and entered the world of negative rates.   Whether it finds the White Knight to rescue it remains to be seen...