BOJ's Policy Calls Are Being Made In Washington And Beijing

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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.”

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.