Patrick (00:00)
Welcome back to the Barclays Brief.
Japan is back in the headlines. It's the world's fourth largest economy. Home to one of the world's largest bond markets. And it's also one of the biggest pools of capital anywhere globally. That means changes in Japanese interest rates and bond yields can and do influence where investors put their money, both at home and abroad.
So, as we've been reminded recently, what happens in Tokyo doesn't just stay in Tokyo.
If we zoom out. For decades, Japan was defined by deflation, zero interest rates and a weak yen. But that's changing quickly. Inflation is back, rates are rising, and just a few weeks ago, we saw something remarkable. Japanese authorities intervened to support and strengthen the yen, with the US joining for the first time in decades.
It means it's a great time to talk about Japan today, because we have a very unusual combination of a weak currency, rising bond yields and a very strong equity market as well. So, what's going on? Why does the Yen remain weak?
What's the Bank of Japan trying to achieve and how should global investors think about this?
Joining me to discuss all of that is Yoichi Takemura, Head of Macro Trading in Japan. Taka, thanks for being on the podcast with me today.
Takemura (01:25)
Pleased to be here. Thanks for inviting me and look forward to speaking about Japan.
Patrick (01:30)
Thank you. So, it’s the end of your day. It's the start of mine over here in London. Japan has obviously been back in the headlines. Investors care a lot about it. And the Yen has been one of the biggest market stories. Why is it so weak? Despite Japan finally emerging from decades of ultra-low inflation and raising rates?
Takemura (01:51)
I think it's mainly because of capital flight. The Japanese household still has 50% of their assets in cash, and for the last three decades, when there was deflation, people were happily sleeping with their cash under the pillow. Since pandemic inflation started happening, people started panicking. They put money into equities and foreign assets. And that has been driving bigger currency, which is more capital flight.
Patrick (02:21)
Sure. And so, we've seen very strong Japanese equity performance the last year or two. Let's just focus on that currency intervention.
So, the MRF intervened a few weeks ago and the US followed suit. How is the market digesting those interventions? What happened to the yen? And what's the market now expecting?
Takemura (02:41)
Let me explain why Japan needed it affects intervention. Japan inports 90% of the energy and 60% of the food. And this limitation of how far the weakness of yen can go, even that affects inflation for households.
Japan could have done soul intervention. But instead, as the help from the US ended up becoming a coordinated intervention.
It was a clear benefit from Japan's perspective and from a US perspective, there are a few benefits as well, such as weakness in the Yen is affecting broader weakness in other currencies or rising yields in the back end of the curve.
But this time, Japan seems to have really asked for the help from the US. And the market expectation is it was FX intervention was done. The Yen is still trading about 200 day moving average even after the weak payroll on Friday. The next action needs to be taken by policy changes by central bank.
Patrick (03:54)
Really the story is intervention can only do so much. Ultimately, investors now are asking whether the Bank of Japan itself needs to become more aggressive. Talk about what happened in trading today in Japan and where the market is in terms of pricing the next rate hike.
Takemura (04:10)
The market is pricing roughly about September, January and June hikes. We had the last hike in June, and the next hike will be in September means, hike is happening only after one meeting. Then thereafter every three meetings, which is much faster than prior every half a year or every four years. The market is already pricing in some sort of hike acceleration. I think the most okay scenario you can possibly go is hike every three months or every other meeting. Which market is pricing in about 40/50% of the probability today.
Patrick (04:52)
And am I right in saying that because of the way that the board is set up in the Bank of Japan, is unlikely that the hiking cycle will be any more than every three months? Do you want to explain that for our listeners?
Takemura (05:05)
The Prime Minister will pushback if the BOJ goes to them and says they want to hike every meeting. She's a strong proponent of reflation. Very famous. She thinks BOJ is a subsidiary of the government. And that's why market never thinks BOJ can hike to new to rate, which I think is well above 2%. Instead, the market thinks the terminal rate is lower than new to rate.
Patrick (05:38)
Okay. And so, talking about PM Takahashi, let's zoom out and think about the wider economy in Japan, because the last time we focused on Japan on this podcast, it was the day after Takahashi's decisive victory at the polls.
Her approval rating then was extremely high. It's still very high. What policies is she pursuing that catching your client's attention? And how are those policies impacting markets?
Takemura (06:04)
She is a strong proponent of reflection, and she thinks the BOJ is a subsidiary of the government. Those two have been the primary themes that the market have been focusing on. From day one, Takeuchi's approval rating was very high, which has come off a bit, but still very high today, and the gap between her approval rating and the ruling political parties, which is LDP's approval rating, is still about 30% today.
Patrick (06:33)
Which is very wide compared with history.
Takemura (06:35)
It is very wide. It's been about ten months since her inauguration. What has changed is her thinking of how strongly she can go with. She has become more vocal about implementing fiscal stimulus because her approval rating has remained high.
Patrick (06:55)
Okay, so her approval rating is very high. She's clearly very focused on fiscal expansion. Talking about defence, she has this 370tn yen investment plan about lower bats for food refundable tax credits. There's lots of policies she's implementing. If we think then about sitting here in a year's time and we're talking, what do you think the market will be saying about Japan that would sound surprising today?
What are the themes that maybe are being missed by investors that you that you see some interesting trade ideas?
Takemura (07:28)
I think the probability of data emergency in Japan is still underpriced. It's somewhat pricing, but rating agencies even saying that doesn't have any fiscal issues for the next couple of years. That the GDP ratio will continue coming off. Not because Takahashi is doing a great job, but nominal GDP growth rate is higher than nominal rates.
The expected path for Japan is that interest payments to GDP ratio is currently 1.8% today, which is going to be 5.5 to 6% in 2040 - significantly higher. And we're going to have fewer population over the next 15 years or even longer time horizon, and senior ratio will increase from 30% today to 35% in 2040.
There is a significant possibility of that divergence happening in Japan sooner or later. It's not going to be under the Takahashi administration because of this redemption schedule, and SG or nominal growth rate is higher than nominal rates. Not because Takashi is doing a great job. So whoever takes over the Prime Minister post after, they will be facing those issues in a couple years’ time.
And that's, I think when the market realises there is a significant higher divergence risk.
Patrick (09:01)
How are our clients thinking about trading that in Japan?
Takemura (09:04)
People usually want to have a bear flattening positions in rates. But there is a limitation for lightning to be happening for two reasons. One, people never think music and hike up to neutral, always lower than neutral. Two, there is a debt divergence risk, they need some additional fiscal premium. I think significant flattening or any reasons is a fade.
Patrick (09:35)
Thank you very much.
So as the market in Japan closes and the market in London is about to open, the key message from this conversation, I think, is it's impossible to ignore Japan, whether it's the direction of the yen, the pace of the Bank of Japan's tightening schedule, the impact of fiscal policy, or the behaviour of one of the world's largest pours of capital. Developments in Japan increasingly shape conversations well beyond its borders.
Thanks a lot for listening to the Barclays Brief. Do hit subscribe and we'll see you again next time.
