Most developed central banks had Japan as a case study decades long ago, serving as a crystal ball into the future, yet they seemed to ignore the repercussions of the Japanese QE experiment. As Japan went from boom to bust, they ignored all the warning signs and instead embarked on the same path as them.
They say history does not repeat, it rhymes. But in this case, it appears thanks to our elected officials, it seems to do both. The Yen has moved from 115 vs. the Dollar to about 135 today. It has fallen about 15%+ this year after losing about 10% in 2021. Central banks seem to have an endless largesse of money at their hands to buy up Bonds to support markets, but in this case, it cannot have its cake and eat it too. It cannot ask for Bond yields to be below a certain level and for its currency to stay "stable" as well.
Thankfully, there is still a bit of macro-economic fundamentals that still function in the markets.
Bank of Japan
BoJ has been operating under yield curve control whereby they work to keep the 10-year JGB yields capped at 0.25%. This means endless QE and money printing as they become the largest owner of their own debt. After Covid, central banks printed about $30 trillion in a short span of time and thought inflation would be transitory. Perhaps that was just a line they used so they could buy up options in the market before and cash out in Q4 before the market collapse. Inflation is now averaging about 8.5% y/y in the US, not to mention closer to 15%-20% in Emerging Markets.
The system that has been built on so much debt that it cannot handle higher rates at all. Every time central banks try to raise rates, something snaps and they have to reverse policy again. The Japanese Bond yields have been suppressed like trying to contain steam in a pressure cooker after too much pressure has been building up inside, and the valve is about to break. The BoJ is literally sitting and leaning over it to keep it from bursting, but the pressure (inflation) is just too much for it stay in control. That is the state of the Japanese Bond market where 10-year yields are breaking above despite all their buying. This endless money printing will and has seen the Yen fall, after all they have to choose the lesser of the evils, but cannot save both.
As the Yen weakens, it is causing devaluation concerns among the other Asian exporters as their currency strength keeps them at a competitive disadvantage, causing them to fall as well to keep up with the latest devaluation. As the Yen falls, all Yen denominated savings need a place to run to, the Dollar perhaps, which sees even more outflows and capital flight.
The Yen and FX Markets
We all know how important the Yen is for FX markets and if this carries on, it has serious deleveraging implications for markets judging by past currency crises. The financial system is built like a Jenga Tower, one wrong piece comes out, and the tower can come crashing down. Higher inflation causes Bonds to collapse as yields rally. 30-year fixed rate mortgages have doubled to north of 6%. Housing affordability has fallen which suggest house prices need to fall by 30% for a person to be able to afford the same house. Inflation is a lit match stick that has been thrown right into the barrel of Oil, that is the economy. It is the nemesis of any central banker and Volcker knew that all too well.
Most do not look at the Yen but it has been the source of great pain in past systemic collapses. Christine Lagarde would be better served reading some of the history books as it seems the ECB is on the same path as the BoJ with their currency effectively getting worthless by the day. At least one can commend the US Fed for at least "trying" to raise rates. The ECB's balance sheet is a one way upward trending chart. It is a sign of madness to keep doing the same experiment again and again expecting a different result. But then again perhaps these central bankers are all mad to begin with.
