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Bank of Japan Blows Record $81 Billion Defending It's No Rate Hike Pledge

After spending $81 billion defending its bond pledge, what will it do tomorrow?
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Open  Wallet image courtesy of Bloomberg. Bank of Japan deploys over 10 Trillion Yen. 

Open  Wallet image courtesy of Bloomberg. Bank of Japan deploys over 10 Trillion Yen. 

Bank of Japan deploys over 10.94 trillion Yen in an attempt to hold its 10-year interest rate peg to 0.25 percent. 

Bloomberg reports It Took a Record $81 Billion Bond Buy for BOJ to Restore Calm

Ten-year yields edged higher to 0.23% Monday in the aftermath of the BOJ’s 10.9 trillion yen ($81 billion) of government bond purchases last week, the most on record, data compiled by Bloomberg show. The central bank ramped up bond buying as benchmark yields breached its 0.25% tolerated limit amid a global debt selloff.

By way of comparison, European Central Bank asset purchases under its so-called APP program averaged about $27 billion -- per month -- this year through May.

Crisis Mode

10-Year Japanese Bond market volatility.

10-Year Japanese Bond market volatility.

Enter "Mr. JGB"

The appointment of a Japanese government bond expert with experience of the market turmoil of the late 1990s to a key role in the Finance Ministry has caught the attention of market watchers in Tokyo. Michio Saito -- dubbed “Mr. JGB” -- will head up a division that covers the bond market and may strengthen lines of communication with the central bank, according to some strategists.

Speculative Attacks 

Please note Hedge Fund BlueBay Is Shorting Japanese Bonds Until BOJ Breaks

  • BlueBay’s London-based chief investment officer, Mark Dowding, told Bloomberg on June 14 that it had a "sizable short on JGBs.” 
  • Deutsche Bank macro strategist Jim Reid wrote in a note to clients  “The last man standing continues to be the BOJ and to be honest the more the market attacks the Fed and the ECB the more likely it is that the BOJ own forward guidance (in the form of YCC) will end very messily with huge implications for global rates” 
  • We do think that the BOJ will be forced to capitulate at some point,” Russel Matthews, senior portfolio manager at BlueBay.

Shades of Soros

On September 16, 1992 George Soros Broke the Bank of England.

Soros is known as "The Man Who Broke the Bank of England" because of his short sale of US$10 billion worth of pounds sterling, which made him a profit of $1 billion during the 1992 Black Wednesday UK currency crisis. Based on his early studies of philosophy, Soros formulated the General Theory of Reflexivity for capital markets, which he says renders a clear picture of asset bubbles and fundamental/market value of securities, as well as value discrepancies used for shorting and swapping stocks.

Soros had been building a huge short position in pounds sterling for months leading up to the Black Wednesday of September 1992. Soros had recognized the unfavorable position of the United Kingdom in the European Exchange Rate Mechanism [ERM]. For Soros, the rate at which the United Kingdom was brought into the European Exchange Rate Mechanism was too high, their inflation was also much too high (triple the German rate), and British interest rates were hurting their asset prices.

By September 16, 1992, the day of Black Wednesday, Soros's fund had sold short more than $10 billion in pounds, profiting from the UK government's reluctance to either raise its interest rates to levels comparable to those of other European Exchange Rate Mechanism countries or float its currency.

Finally, the UK withdrew from the European Exchange Rate Mechanism, devaluing the pound. Soros's profit on the bet was estimated at over $1 billion. He was dubbed "the man who broke the Bank of England".

In 1999, economist Paul Krugman was critical of Soros's effect on financial markets. "Nobody who has read a business magazine in the last few years can be unaware that these days there really are investors who not only move money in anticipation of a currency crisis, but actually do their best to trigger that crisis for fun and profit. These new actors on the scene do not yet have a standard name; my proposed term is 'Soroi'."

The ERM was created 1979 to reduce exchange rate variability and stabilize monetary policy across Europe before introducing the Euro.

In joining the ERM, the Bank of England was obligated to keep the British Pound in a range of  2.78 to 3.13. 

Soros bet the Bank of England (BOE) would not be able to do that.

The BOE kept pledging more and more money defending the peg. It even hiked rates to 15% to defend the range peg.

When informed of this Soros replied, "What are they going to do tomorrow?

The BOE capitulated in an emergency meeting. Soros made a billion dollars, an amazing amount of money in 1992.

Japan's Currency Intervention 

On June 10, Reuters explained What Currency Intervention to Combat a Weak Yen Look Like

"We have seen sharp yen declines and are concerned about recent currency market moves," the Ministry of Finance, BOJ and the Financial Services Agency said in the joint statement released after their executives' meeting.

The latest jaw-boning came a day after the yen hit a fresh 20-year low against the dollar and a seven-year trough against the euro on expectations the Bank of Japan (BOJ) will continue to lag behind other major central banks in exiting stimulus policy.

Aside from verbal intervention, Japan has several options to stem excessive yen falls. Among them is to directly intervene in the currency market and buy up large amounts of yen.

Yen-buying intervention has been very rare. The last time Japan intervened to support its currency was in 1998, when the Asian financial crisis triggered a yen sell-off and a rapid capital outflow from the region. Before that, Tokyo intervened to counter yen falls in 1991-1992.

When Japan intervenes to stem yen rises, the Ministry of Finance issues short-term bills to raise yen which it can then sell in the market to weaken the Japanese currency's value.

Yen-buying intervention is more difficult than yen-selling.

If it were to conduct intervention to stop yen falls, authorities must tap Japan's foreign reserves for dollars to sell in the market in exchange for yen.

Japan's foreign reserves stand at $1.33 trillion, the world's second largest after China's and likely comprised mostly of dollars. While abundant, reserves could quickly dwindle if huge sums are required to influence rates each time Tokyo steps in.

Collapse of the Yen

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Japanese Yen courtesy of Trading Economics

Japanese Yen courtesy of Trading Economics

Up is Down

In Mid-2012 it took about 78 yen to buy a dollar. Now it takes 135. 

That's a 42 percent decline in the value of the yen. Some invert the chart so that down looks down. 

Japan's Balance of Trade

Japan needs massive food and energy imports with the Yen sinking and food and energy costs soaring.

On March 8, Reuters reported Japan logs biggest current account deficit since 2014 as oil import costs surge

Japan, the world's third-largest economy, posted a current account deficit of 1.1887 trillion yen ($10.31 billion) in January, the data showed, versus economists' median estimate of a 880 billion yen deficit in a Reuters poll.

It was the second straight month of deficit and marked the second largest deficit under comparable data going back to 1985.

Surging fuel costs drove up the value of imports by 39.9% in January from a year earlier, outpacing a 15.2% rise in exports.

Fool's Move

Selling US dollar reserves to shore up the Yen would be a fool's move. If anything, it would make a collapse in the Yen more likely. 

As the US enters recession, Japan's export machine does not look so hot, to say the least. 

If "Mr. JGB" starts selling US treasuries to prop up the Yen, it's likely to elicit howls from the US. 

And it will get this reaction from me: What's Mr. JGB going to do tomorrow? 

End of the 40-Year Bull in Debt and a “Global Depression” Threat

In case you missed it, the ECB has a similar dilemma.

For discussion, please see The ECB Has a Huge Dilemma: Price stability or Bail Out Nations

Finally, please take another look at End of the 40-Year Bull in Debt and a “Global Depression” Threat

Over the years I maintained a currency crisis was far more likely in Japan than the US. We will see. Regardless, the end of the 40-year bull market in debt does not rate to be a pretty affair.

This post originated at MishTalk.Com.

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