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Pachinko Anyone?


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When I was a kid in the 1970s, I had a neighborhood friend whose dad had a job that required world travel. After one trip, his dad came back from Japan with the coolest thing I had ever seen—a Pachinko table. The table was essentially a vertical standing version of the most awesome pinball machine we ever got our hands on. You would use a spring action lever to fire little steel balls up to the top. The ball would then careen off a ton of pins, cups, and traps on its way down. If the ball landed in certain spots, you were rewarded more balls for play. If the ball fell into one of the many traps on the table, you lost that ball. It was awesome.

This morning, I feel like the Japanese Yen is one of those pachinko balls bouncing and careening from one spot on the table to the next, unable to gain control over where it is going. Meanwhile, the poor Governor of the Bank of Japan (BOJ), Haruhiko Kuroda, is hanging on to the ball for dear life. Earlier this year, a stalled Japanese economy coupled with the rising value of the Japanese Yen, put increased pressure on the economy and punished the Japanese stock market. As a result, Governor Kuroda was compelled to pursue the extreme monetary policy known as Negative Interest Rate Policy (NIRP).

The policy was supposed to spark bank lending and weaken the Yen. Instead, the Yen increased in value, and banks screamed in pain as the dual effect of participating in the BOJ’s massive Quantitative Easing (QE) program and NIRP put them in a serious hurt locker. Things got so bad for Japanese banks that one of the biggest, Bank of Tokyo-Mitsubishi UFJ, actually quit as a primary dealer of Japanese Government Bonds (JGBs). In the United States, this would be the equivalent of JPMorgan Chase telling the Treasury Department they were pulling out as a primary dealer of U.S. Treasury securities—something that we would consider unthinkable. If this were a TV show, it might have been called “Everybody Hates Haruhiko.”

Throughout the year, the Yen continued to rise, and the Japanese economy continued to sink. Then two weeks ago, Prime Minister Abe announced that a large stimulus package was coming and the BOJ’s policies should dovetail with this new fiscal policy. Many took that as a signal that Kuroda should initiate the most extreme type of monetary policy, “Helicopter Money,” where the central bank directly funds government spending. With “Helicopter Money” rumor swirling, the Nikkei increased over 9%, the Yen weakened over 6% against the U.S. Dollar, and risk assets had a party. This longevity of this rebound in risk assets hinged on the BOJ and Governor Kuroda delivering something big at their July 29 meeting. This Wednesday, Prime Minister Abe announced that a stimulus package of about 20-30 trillion Yen was coming. However, those familiar with the Japanese fiscal process have determined that only seven trillion Yen (about $68 billion) would actually be new spending. Essentially, Prime Minister Abe dumped Japan’s problems back into Kuroda’s lap.

First, Governor Kuroda had to dissuade the markets of the notion that the BOJ was going to explicitly print money out of thin air by saying no to “Helicopter Money.” Then, last night, the BOJ “disappointed” the markets by not increasing NIRP or government bond purchases under their QE program. Governor Kuroda is essentially saying that NIRP doesn’t work and QE, as far as government bond buying, has hit its limit. The only thing the BOJ did do was announce that they will increase purchases of ETFs (stocks) by 2.7 trillion Yen, or $26 billion. I think he had to do that, otherwise the Nikkei would have dropped 6% last night! The Yen has now strengthened 2.1% since the announcement and seems to be bent on getting back to a level of 100 Yen to the U.S. Dollar. The Nikkei will soon give back that 9% it made in the two weeks of “Helicopter Money Euphoria.” The BOJ is essentially out of bullets, at least bullets that don’t shoot them in the foot.

In last week’s piece, I thought that we could see 10-year Treasury rates go back to the 1.40s. We are there this morning off of the disappointing BOJ announcement, WTI Crude falling to the low $40s, and lower than expected second quarter U.S. GDP (2.5% growth was expected, it came in at 1.2%). I think August is going to be ugly for stocks and commodities. I think the direction for the long end of the Treasury curve continues to be lower in yield, and I think the Treasury yield curve will flatten.

Member SIPC & FINRA. Advisory services offered through SWBC Investment Company, a Registered Investment Advisor.

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