Category Archives: Japan

BoJ Soon to Take Its Deflation Fight to Another Level

I believe Japan’s aggressive monetary policies will continue to reward those who invest in its stock market. To review, the first arrow of Japanese PM Shinzo Abe’s “three arrows” of economic policy, aggressive monetary easing, was implemented by BOJ governor Haruhiko Kuroda to eradicate Japan’s long-standing deflationary pressures. In April 2013, soon after Kuroda became Governor, the BOJ introduced “Qualitative and Quantitative Easing” (QQE) which has since been expanded. Currently, the BoJ is buying annually 80 trillion yen of JGBs, 90 billion yen of  JREITS, and 3.3 trillion yen of ETFs. The money printing has caused the Nikkei to rally by 45% and the yen to depreciate by 28% against the US dollar up to January of this year.

Nikkei Performance During 1st Arrow


On January 29th, the BOJ tried to provide additional monetary stimulus by applying negative interest rates to banks’ excess reserves so that banks would be motivated to lend. However, the move backfired as the Nikkei has fallen 4% since then while the S&P 500 rallied 9% and the yen strengthened by 8%. A likely explanation for this market reaction:

BofA noted that the policy of applying negative rates to banks’ excess reserves didn’t take effect until mid-February and trust banks began passing the cost on to fund management companies in mid-April. That spurred the management companies to pass the cost on to investors, which worked against the BOJ’s efforts to encourage portfolios to rebalance toward riskier assets, BofA noted.

Although, I am not certain that negative interest rates is such a couter-productive policy, the fact that the financial media has widely panned it will prevent central banks from moving further in that direction. As almost all central bankers believe, a prerequisite for a monetary measure being successful is confidence from the public that it will work. Given the market’s current aversion towards negative interest rates, the BoJ is unlikely to rely on it going forward.

Kuroda’s recent statement that the BOJ can still ease policy substantially, indicates that the BoJ is likely to lean on QQE going forward. I doubt that it will cause the yen to depreciate as it did during the past couple of years because, despite the BoJ’s massive money printing, Japan’s money supply growth lags the 5%+ growth seen in the US.

Japan M2 Growth

Conversely, the yen is unlikely to experience a major appreciation since the large number of speculators which have shorted the yen over the past 3 years have unwounded their positions. In fact, speculators are now net long the yen.

Yen SpeculatorsSource:

QQE could nonetheless boost equity valuations. I believe the BoJ will expand QQE this summer via increasing the rate of ETF purchases. At the current rate, the BOJ is running out of JGBs to buy and will own 50% of all outstanding government bonds by 2018. Also, the amount of current ETF buying ($3.3 trillion a year) pales in comparison to the 80 trillion yen of government bonds it purchases.

The increased demand for Japanese stocks resulting from BoJ buying, coupled with a low valuation of only 13.6x earnings could lead to decent though not spectacular returns. I have been long Japanese stocks while hedging yen depreciation; I intend to maintain the position, but will sell if there is a significant rally.

Buying Nikkei Futures Priced in $USD

I tweeted on Thursday that I thought that there was a greater than expected chance for the Bank of Japan to positively surprise markets and increase its QE program. The BOJ did increase its QE amounts and I tweeted that I bought Nikkei futures as the market exploded higher.

I believe Japan’s 22 year secular bear market ended in November 2012 when the Nikkei rose by 85% in just 6 months. After 17 months of consolidation, Japanese stocks look ready to make another big move up.

Nikkei Long Term Chart-2

My bullishness on Japan rests mainly on Prime Minister Shinzo Abe’s determination to create inflation. As shown on the following chart, Japan has had virtually no inflation over the last two decades meaning that the BOJ has been unable to provide negative real interest rates for the Japanese economy.

Long Term Japan CPI & Interest Rates-2

When Abe was elected, he pushed for the BOJ to increase its inflation target to 2% and named Haruhiko Kuroda as new BOJ Governor. Kuroda, who is cut from the same cloth as Bernanke and Draghi, believes deflation must be fought off with aggressive monetary easing to raise long term inflation expectations. That, he argues, would lower real interest rates and encourage spending.

In fact, Kuroda had been arguing for the BOJ to adopt an inflation target a decade before it set one in January of last year and has spoken in favor of QE for years. And he lived up to his dovish reputation at his first meeting as BOJ governor by announcing that the BOJ was going to double the monetary base within 20 months.

Despite this, economists estimate that Japan’s inflation rate is likely to fall well below its 2% target by next year. The recent drop in oil prices is a further deflationary shock, but gave Kuroda an opportunity to add to stimulus. Last Friday’s BOJ’s announcement of expanding its already enormous QE program makes it clear that he is adamant about hitting the BOJ’s inflation target.

To grasp the enormity of the program, consider that the BOJ is committing to expand its balance sheet by 17% of GDP annually – equivalent to the Federal Reserve implementing QE1, QE2  and QE3 at the same time. As proven by the Fed’s and BOJ’s QE programs, it can force people into bidding more for riskier assets causing stock prices to surge.

Central Bank Assets  (% of GDP)-3

But what makes Japanese stocks particularly attractive is that they are still reasonably priced. They trade for less than 14x forward earnings and 1.3x book value. The recent depreciation of the yen and the fall in energy prices make it increasingly likely that forward earnings estimates will be reached. And if Abe is successfully able to implement the third arrow of Abenomics, structural reform, then Japanese equities could do even better than I expect.

I decided to buy the $US denominated Nikkei futures trading on the CME because I am concerned about continuing yen weakness and the risk of a Japanese government debt crisis down the road. Japan’s debt load is so enormous that I believe it is already insolvent though it will ironically require the BOJ to successfully create meaningful inflation for the markets to get spooked. In the meantime, I expect Japanese stocks to experience a crack up boom. I will track my trade here.

Japanese Individuals Getting In on the Yen Carry Trade

The WSJ reports that Japanese individuals are engaging in the yen carry trade, too.

Now people such as Naomi Kashiwazaki, 29 years old, have joined the fray. She trades currencies from her small apartment in Tokyo’s suburbs. She started about a year and a half ago to supplement the income from her online store, which sells designer athletic shoes that are hard to find in Japan. In recent months, she has earned an average profit of $8,600 a month.

“I must say, I am addicted to this now,” she says.

Tens of thousands of other investors like her are doing the same thing. With Japanese interest rates hovering at a low 0.5%, they borrow big piles of yen cheaply and then invest it in currencies elsewhere, looking for higher returns. Ms. Kashiwazaki makes trades totaling $200,000 or so a day among several currencies, ranging from the U.S. dollar to the Swiss franc.

As the yen gyrated over the past week, traders such as these are believed to have played a major role in the volatility. Last week, the yen gained 3.5% against the dollar.

“Japanese individuals are doing essentially the same thing as hedge funds,” says Tohru Sasaki, chief foreign-exchange strategist at J.P. Morgan Chase Bank in Tokyo. “Together they are acting like an enormous hedge fund.”

A combination of technology, deregulation and low interest rates is enabling individual Japanese to use the same kind of investment techniques as the pros. Borrowing money to trade currencies has become so popular in Japan that individual traders — sitting at their computers in homes across the country — now trade tens of billions of dollars a day, according to some estimates.

J.P. Morgan strategist Mr. Sasaki estimates that in the months leading up to last week’s sharp movements, Japanese individuals some days held foreign currency valued at more than five trillion yen, or $43 billion. That is similar to his estimate for the amount of yen loans taken out by professional investors in order to speculate in foreign currencies.

I have written before about the significance of the yen carry trade. This article supports my argument by showing how widespread it has become.

Buying the Yen ETF

In my previous post I mentioned that I was sitting on 20% cash. Today I decided to use almost all of that cash to buy the CurrencyShares Japanese Yen Trust (NYSE:FXY) for $82.75 per share. In effect, I am still in cash — albeit yen rather that dollars.

My motivation for this trade is that I believe the yen carry trade will soon end, which will cause the yen to appreciate against most currencies. Last year, the yen was one of the worst performing currencies in the world. This year it could be the best.


As a contrarian, I am also delighted to see that there is a record speculative short position in the yen.


It should be noted that, unlike the other CurrencyShares, the Japanese Yen Trust currently doesn’t pay any dividends because Japanese interest rates are barely able to cover the trust’s expense ratio. But I believe a rise in the yen will more than make up for this shortcoming.

Yen Carry Trade Could End in 2007

The yen carry trade has been a major source of global liquidity since 2001 when Japan’s central bank cut rates to nearly zero while managing the US dollar-yen exchange rate. It’s intention was to stimulate Japan’s consumer spending and exports.

This policy allowed financial institutions to borrow funds from Japan and invest in assets offering higher returns such as emerging market equities and US bonds. For example, a hedge fund could borrow $100 million from Japan at 0.4% interest and use leverage to buy $1 billion short-term US treasury bonds yielding 5%. After one year, the hedge fund could close the bond position with $150 million. After paying off the loan in Japan it’s net profit would be close to $50 million and it would have earned a 50% return.

This assumes that Japanese interest rates don’t go up and the yen doesn’t appreciate. On January 18, the Bank of Japan decided not to raise rates and keep its key short-term rate at just 0.25%. With no signs that interest rates will rise anytime soon, the carry trade has picked up steam. According to a January 26 report by Barclays Capital the magnitude of yen-funded carry trades “is reaching scary levels” not seen since 1998.

Also, speculative short positions in the yen are at record levels:


Being a contrarian, I suspect that the yen carry trade will still reverse in the near future. Although Japanese interest rates may not rise, the carry trade could become unprofitable if the yen started to appreciate against other currencies. This is possible if Japan’s economy strengthens leading to greater corporate profits and rising equity prices. Then the Japanese stock market, which was one of the wost performing stock markets last year, would begin to out-perform global assets. This would cause capital to return to Japan and the yen to appreciate.

Another possibility is that the weakness in the US housing market causes consumer spending to taper off and the economy to slow down. In response, the Fed would cut rates which would cause inflation to accelerate and the bond market to decline. The US dollar would weaken making a major portion of carry trades that borrow yen to invest in US bonds unprofitable. Hedge funds would then be forced to cut losses and return the capital to Japan causing the yen to appreciate further. This would lead to a reversal of carry trades that invest in assets in other parts of the world. In the end, global asset prices could plummet.

Of course sudden and unexpected non-economic events could also blow up the yen carry trade. Possible triggers include an escalation in Middle East tensions, major terrorist attacks or a bird-flu pandemic.

Last spring the world got a taste of how bad asset markets could falter when the Bank of Japan announced its intention to abandon the zero interest rate policy. The yen appreciated against the US dollar by 8% during April and mid-May. Hedge funds began to unwind the carry trade in May and the ensuing sell-off in asset prices continued through mid-June. The S&P 500 fell by 5%, Japan’s Nikkei fell by 17%, most emerging markets’ equities fell by 20-30%, gold fell by 22%, and copper fell by 21%.

In late 1998 Russia’s debt default accelerated the implosion of Long-Term Capital Management LP and caused a panic in markets. Investors scaling back their carry-trade positions drove the yen up 20 percent in less than two months.

The best way to play this is to go long yen. Since I don’t trade futures I intend to simply sit on the sidelines and watch as asset prices fall. Hopefully, gold will also correct which would present an opportunity to buy some of my favorite gold stocks cheaper than today.