Research Team at BBH, suggests that the BOJ's move to negative rates at the end of January has been the only policy surprise among the major central banks this year.
“The yen's seemingly perverse reaction may be explained by the risk-off portfolio adjustments that led to covering of short yen positions used for funding and hedging.
Many focus on the impact of the yen's rise on exports. This is true if all else is equal but it is not. Japan exports less than 15% of GDP. This is about the same as the US. Several European countries, including Germany, exports around 40% of GDP. Since the mid-1990s, Minister of Finance data shows that Japanese companies, like American companies, service foreign demand primarily through local production. Most of the Japanese-brand cars driven in the US were made in the US. Some Japanese producers exports back to home.
The more important channel seems financial. A stronger yen lowers the value of overseas earnings. This squeezes profits and margins. Toyota is a case in point. The union asked for a JPY3000 (~$27) increase in the monthly pay, the least in three years. The company said it is not able to afford even JPY1000 a month.
Among the reasons Toyota cited, according to press reports, was unfavorable international climate. For the record, reports indicate Toyota is on pace to earn JPY3 trillion this fiscal year, which is more than twice what it earned in 2013. The division of profits between earnings and wages is not simply a function of economics. Japan has full employment by nearly any measure. Wages influenced by a power relationship and the power extends beyond the marketplace.
Japanese companies seem to recognize that unions are too weak to make strong demands or even enforce its weak demands. The government has neither the will nor value-system that would force business to increase wages. Japanese officials are facilitating the creation of ETFs that will be bought by the BOJ in its QQE operations that are constructed to favor those businesses that adopt the best practices that is part of Abenomics third arrow.
The strong yen reduces the current account through the yen value of the investment income earned abroad. Investment income include dividends, coupons, royalty and licensing fees, for example. Unappreciated by many, it is the investment income account that drives Japan's current account position.
Consider that on a balance of payments basis, Japan's trade balance has averaged a monthly deficit of JPY164.5 bln in the three-month period through January, and a JPY16.5 bln deficit in the 12-months through January. The average monthly current account surplus has been JPY875 bln for the three-month period and JPY1.42 trillion over the 12-month period through January.
The yen's recovery could also reverse the imported inflation that previously helped lift price pressures in Japan. Japan reports February consumer price inflation on March 24. The core rate is expected to be unchanged at zero. The measure that excludes energy as well may tick up to 0.8% which is what is has averaged since the middle of last year. Abe and Kuroda cannot be pleased.
They defined a goal, precise measure of inflation to target, a timeframe, and appear to have carte blanche in terms of tools. The BOJ is buying a wider array of assets in larger size than any other central bank. Abe and Kuroda have taken unspecified financial risks to achieve a goal that there is a reasonable and increasing chance that the inflation target has still not been met by the time their terms have ended (2018).”
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