The yen has been really active ahead of the BOJ’s monetary policy meeting this Friday. Markets seem convinced, and economists agree, that the central bank will keep rates unchanged, though likely talk tough to support the yen. However, some analysts say there is a small chance that the BOJ could pull the trigger on a rate hike to calm markets.
Multiple factors have been driving the yen lately, which explains some of the ups and downs. But the key underlying issue is that Japan’s new Prime Minister, Sanae Takaichi, might be facing something similar to a Liz Truss moment. Soon after taking office, she announced new fiscal policy measures that have failed to reassure bondholders who are now offloading Japanese debt. The subsequent spike in long-term yields to record highs suggests problems in Japan’s financial markets, putting increased pressure on the BOJ to act.
Elections and Financial Crisis
On Monday, Takaichi formally called for snap elections on February 8th, which in itself wouldn’t trigger a bond rout. The problem is that Japan has the highest debt-to-GDP ratio in the world. With interest rates remaining near zero and inflation above target, this is largely not a problem for the nation’s finances.
However, after Takaichi announced an aggressive spending program to prime the economic pump, Japanese politicians are looking to woo voters by promising tax cuts. Those include reversing the controversial sales tax increase of a few years ago. The combination of higher spending, lower revenue, and limited capacity to increase borrowing has left bondholders nervous. This was a very similar situation to the one faced by Liz Truss in the UK, which caused the “mini Budget” crisis, forcing the BOE to intervene to support the market. Higher yields mean the debt is worth less, and if they rise too much, financial companies that hold the debt will have to take significant write-offs on their profits. A worst-case scenario of long-term debt rising too quickly would trigger a financial crisis as major banks, insurance companies, and other financial firms trigger a cascade of bankruptcies.
Joint Intervention or Rate Cut?
Naturally, the yen has depreciated amid investor nervousness. This has upset regulators, who have been using increasingly strong rhetoric about intervention to shore up the yen. This seems to have worked on Tuesday, after Finance Minister Satsuki Katayama all but promised to intervene in the market. Traders are now speculating on when, rather than if, the BOJ will step in. In the wake of the Minister’s comments, the yen has stabilized.
What would have the greatest impact on the market is if the BOJ and the Fed were to initiate coordinated intervention, as Katayama hinted. US Treasury Secretary Scott Bessent, speaking in Davos on Wednesday, showed support for joint intervention if necessary. While it is likely to have a major impact on the market, it is a weapon of last resort for the government.
What Will the BOJ Do?
The BOJ is widely expected to raise rates at some point, but the futures market is pricing in a hike no earlier than the next quarter. The central bank has to be careful not to raise rates too fast, because higher rates would put upward pressure on yields. However, a surprise rate hike would help stabilise the currency and slow the flight from bondholders, while leaving the possibility of intervention on the table.
On the other hand, the central bank will be inclined not to shake things up during an election, so a policy change would be a major surprise for markets. For now, the consensus is that policy will be left on hold, while BOJ Governor Kazuo Ueda tries to cajole the market into behaving.
