Banks Power is On: Japan Has a New Central Bank Governor, and Inflation is on the Rise. That is Good for Both the Yen and Bonds.
Apr 14, 2023
The banks power is on. On April 9, Kazuo Ueda was sworn in as Japan’s central bank chief, following Haruhiko Kuroda, who had held the position for ten years. It may be a terrific time for the world’s third-largest economy.
For much of the globe, inflation is a hated scourge that must be battled to death by central banks hiking interest rates. After decades of deflation, it’s more like manna from heaven for Japan’s policymakers. Kuroda was the high priest of this effort, keeping rates at zero and growing quantitative easing while worldwide peers tightened aggressively.
Inflation has finally arrived in Japan, with import-driven price increases exceeding 3% per year. T. Rowe Price’s portfolio manager for Japanese stocks, Archibald Ciganer, argues that this is the first inflation he has witnessed in Japan in 23 years. Reflation would be a night and day difference.
Markets anticipate that Ueda, an academic economist with a Ph.D. from the Massachusetts Institute of Technology, would eventually reverse Kuroda’s ultra-dovish stance. According to Masamichi Adachi, chief Japan economist at UBS, the BOJ is not in a hurry to begin policy normalization for extra banks power.
With the central bank controlling half of Japan’s $8 trillion bond market, a little policy intervention might go a long way. Any tightening should strengthen the yen while reducing liquidity in global markets. Easy money seeping out of Japan, according to Michael Kelly, head of PineBridge Investments’ multiasset strategy, has been one of the reasons why markets worldwide have been able to defy gravity.
While most central banks are happy to alter prime rates, the Bank of Japan additionally enforces “yield-curve control,” which limits the difference between prime and the yields on other duration bonds.
Investors anticipate Ueda tinkering with this system first, boosting the 10-year paper spread from 50 basis points, or a half-percentage point, to 75 or 100. According to Aaron Hurd, senior currency portfolio manager at State Street Global Advisors, the move might occur during the June BOJ board meeting. UBS’ Adachi believes Ueda should wait until the prospect of a US recession becomes clearer.
Both believe that monetary policy changes should make Japanese bonds more appealing, hence boosting the yen for banks power. Adachi’s objective is 120 per dollar, up from 132 now. Hurd agrees that the yen is one of our preferred currencies.
The picture for Japanese stocks is bleaker. Stocks tend to fall as the yen rises, as the index is dominated by mega-exporters such as Toyota Motor (7203. Japan) and Sony Group (6758. Japan).
T. Rowe Price’s Ciganer seeks to counteract this headwind by investing in conglomerates that are rationalizing their holdings, such as Hitachi (6501. Japan), or improving their governance game, such as Seven & I Holdings (3382. Japan), the parent company of the 7-Eleven franchise in the United States. He’s also discovering growing firms in a sector famed for value, such as Daikin Industries (6367. Japan) and electronics behemoth Keyence (6861. Japan).
Ciganer and Kelly are not following Warren Buffett of Berkshire Hathaway (BRK.A, BRK.B), who unveiled this week a multibillion-dollar increase of his assets in five Japanese trading firms, led by Mitsubishi (8058. Japan) and Mitsui (8031. Japan).
According to Ciganer, the assets of this corporation are primarily located outside of Japan and are heavily weighted toward commodities, making it a dangerous gamble as the global economy cools. Their main benefit is inexpensive borrowing in Japan, which may become less cheap in the near future.
“Buffett spotted the era of free money coming to a close,” Kelly says. “He locked some in the last place where it’s still available.”