World Isn't Ready For What Ueda's Trying To Say

All this caused something of an earthquake in global markets that have relied on free Japanese money since long before the Covid-19 pandemic, the 2008 Lehman Brothers crisis and the September 11, 2001 terrorist attacks on the US.

Since 1999,
Japan has become the world's top
creditor
nation. It's long been routine practice for investors to borrow cheaply in yen and carry those funds over to higher-yielding assets from Argentina to South Africa to India to New Zealand. The leverage these trades facilitate explains why sudden yen moves can cause panic
across asset classes everywhere.

Since Ueda's comments,“the yen's strength seemed to have served as a headwind for the market,” equity analysts at IwaiCosmo Securities wrote in a note.“The rise of the domestic bond yields encouraged sales of large semiconductor shares, which then dragged down the entire market.”

Odds are that in
the short run,“more hawkish rhetoric from the BOJ and the heightened threat of intervention though should help to dampen the scale of any further yen selloff,”
says analyst Lee Hardman at MUFG Bank.

In the longer run, though, the specter of a key funding source since the late 1990s
effectively vanishing is impossible to stress test with any real accuracy.

“The BOJ is the last holdout of the major central banks still supplying liquidity to world markets, so if they get seriabout tightening as well, what does that mean for asset prices, yields and financial stability?” says strategist Benjamin Picton at Rabobank.

“It's little wonder that other central banks are starting to second guess themselves if the last shock absorber is soon to disappear, especially since there is little prospect of China riding to the rescue as it has done in the past,” Picton said.

Many analysts counsel caution, arguing that Ueda wouldn't want Japan to be blamed for the next global financial crisis. In other words,
yield-curve control may end this year, but negative rates will stay around for some time.

“The speed of the yen's depreciation has been slower than last year and is not considered a 'speculative move', making it hard to conduct yen-buying intervention,” says strategist Naomi Muguruma at Mitsubishi UFJ Morgan Stanley Securities.“Ueda's hawkish comments may be intended to keep yen depreciation in check.”

Joseph Capurso, strategist at Commonwealth Bank of Australia, notes that“wage growth remains weak and weakening. We expect dollar-yen's upside momentum to resume” in the days ahead.

The wage problem is its own conundrum. A key reason why Kuroda's approval ratings are in the low 40s at best – and why he reshuffled his Cab– is that inflation gains are outpacing growth in hourly earnings.

It's a problem he could address with policies to offset imported price gains, increase national competitiveness or incentivize companies to share profits with workers.

Yet since the 1990s, Kishida's Liberal Democratic has opted to let aggressive BOJ easing and a weaker yen take the lead. The hope was that this modern take on trickle-down economics would kick off a virtucycle of wage gains that boost consumption and further enrich Japan Inc. It hasn't worked out that way.

Now, Ueda's challenge is to turn back the tide of history and start the process of normalizing rate policy without making matters worse.

Though all top economies turned the keys over to unelected central bankers back in the mid-1990s, none did so more completely than Japan. But the BOJ's grabbing of the economic baton morphed into full-blown mission creep during Governor Masaru Hayami's 1998-2003 term.

When Japan's bad loan crisis deepened as deflation intensified, Hayami pioneered QE when the BOJ became the first major monetary authority to slash interest rates to zero in 1999. In 2000 and 2001, Hayami experimented with negative borrowing costs.

Twenty-four years ago, few could have foreseen the BOJ's role in the economy becoming so absolute or resulting in a long-term commitment to protecting the living standards of 126 million people.

The mechanics of unraveling this conundrum proved beyond the last four BOJ leaders. In 2006 and 2007, Governor Toshihiko Fukui tried ending QE and raising rates – twice, to be exact. But the resulting recession came quickly, and the political backlash arrived even faster.

When successor Masaaki Shirakawa took the reins in 2008, he restored QE . In 2013, Haruhiko Kuroda arrived at BOJ central with a mandate to supersize QE to defeat deflation once and for all.

Kuroda flooded the global financial system with yen and hoarded assets. Within five years, Kuroda's moves to corner bond and stock markets swelled the BOJ's balance sheet to $5 trillion, topping the size of Japan's gross domestic product.

In late 2022, as Kuroda's decade in power was ending, all eyes were on how he might begin to wind down the BOJ's balance sheet. Kuroda punted instead, leaving the unenviable task to the Massachusetts Institute of Technology-trained Ueda, who many felt would bring fresh thinking to the conundrum.

But one of the dark sides of two-pdecades of zero rates is a bubble in complacency, inflated by both the public and private sectors. By being Japan's
24/7
ATM, the BOJ's largess deadened the nation's animal spirits.

Corporate CEOs had little incentive to innovate, restructure or take entrepreneurial risks. Government officials sat back and let the BOJ's liquidity bursts drive growth. In the interim, Japanese government bonds grew in popularity, leaving everyone exposed.

If Japanese government bond yields jumped to 2%, banks, companies, local governments, pension and insurance funds, universities, endowments, the giant postal system and retirees will get hurt.

It's left a“mutually
assured
destruction” dynamic that dissuades virtually anyone from selling debt. The higher yields go, the more difficulty Tokyo will have servicing the developed world's biggest debt burden, representing about 265% of GDP.

Unwinding 24 years of zero rates in a nation hopelessly addicted to the BOJ's monetary welfare is a task that few might relish.

But Ueda may indeed be ready to begin the process of yanking away the proverbial punchbowl. And it's not clear that any economy, company or investor anywhere is truly ready for the market chaos Ueda's next move may soon cause.

Follow William Pesek on X at @WilliamPesek