When the Bank of Japan raised its costs of funds from zero to 0.25%, stocks tumbled and the currency strengthened. What is happening?
This is not just about Japan with its thirty years of zero interest rates but also the differential in interest rates among currencies.
The US Fed raised the interest rate on its Fed funds from zero by a quarter of a percentage point in March 2022, to 4.50% by the end of 2022 to 5.50% today. This major increases were to stamp inflation which unfortunately did not quite work because higher prices came from supply side disruption to the supply chain during covid and subsequently the oil price increases as a result of the Russian attack on Ukraine.
The US rate increases have created problems for many countries which fear the impact of significantly higher local interest rates on their domestic borrowers who are mostly heavily invested in real estate as well as the stock market. As a result, most of these currencies suffered depreciation as savers opted for higher rates in the US dollar. This happens to the yen and the ringgit as well.
In Japan, its main problem had been deflation as a result of the asset bubble which burst in 1991 and real estate had deflated and had been unable to recover since. Borrowers were caught with multi-generational loans and these basically prevented any youngsters from borrowing anew to fund new activities while in the meantime diligent housewives continued to save. Japan pursued a zero interest rate since 1990 to try to persuade housewives to spend and reflate the economy. Perversely, the government was trying all means to create inflation in the economy but to no avail for a long time, until recently.
Tourism is now its tool for reviving the Japan economy which after covid has gained tremendous interest such as there is now an aversion to too much tourism. In the meantime, online trading of ordinary Japanese goods has also increased. While all these economic activities are good for creating jobs and profits in Japan, the currency continues to weaken despite the inflow of tourist money. They discovered that Japanese online trading has been too dependent on foreign logistical and payment systems which they have to pay significant fees on. Of course, underlying the Japanese financial story is the borrowing of zero interest yen from Japanese banks and investing those funds abroad, not only to earn higher interest rates or better profits from expanding markets (see the many new Japanese stores open in major cities in Southeast Asia), but also to benefit from the weakening yen.
In an apparent act of desperation to prevent the yen from a depreciating trend, the BOJ raised its interest rate from 0.1% to 0.25% on 31st July, 2024. This is an act against all global interest rate policies which is to lower interest rates as economies around the world as beginning to falter on account of political interference in private investor decisions which therefore entails a significant realignment of global investor strategies among global companies. (The horse the world has bet on has become unreliable.)
It is to be noted that, as of today, what the slight but contrarian interest rate increase by Japan has caused the yen to rise as (some) funds have been sold and repatriated back to yen. The currencies of some other countries have also strengthened, including the ringgit, in an apparent mimic to the yen.
Many commentators are arguing that this is because of the loss of zero interest rate on the yen, but it is only a 0.15 percentage point increase which is small.
The significance of the (slight) increase in the Japanese interest rate is signal to where the global markets are. That the global markets have been too high for too long and there is now going to be a major adjustment. When this major adjustment happens, don't be the last one holding the baby. So the correct market behaviour is to sell first, and buy back later when prices have fallen enough. This is we see in the global markets today.
Which of course means that the market recovery can be equally quick but probably not to previous highs.
The markets have already known that the global economy is in trouble and they are playing US interest rates coming down. This game is still being played.
The reason for small currencies such as the ringgit to appreciate lately is because forex traders have also been playing on the depreciating trend of the currencies. They could be shorting the currencies and now they have to pull back and cover their positions. In doing so, the currencies strengthened more than necessary. Eventually, everything will fall back to fundamentals.
The economies in the world are in bad shape. Loans are drying up, regardless of whether cheap or expensive. This reduces liquidity. The money supply can be reduced by the decline in the velocity of circulation as less transactions are being made. Cash sits stale in the bank. If you have gold, there is no return and if the price of gold has dropped, then you have lost money. Of course, if you had bought gold earlier, just like every other assets, you are rich asset-wise. To spend you need cash.
The global markets are currently undergoing a quick correction, but they will before long continue as before. Interest-rate disparity among currencies are still there. Economies will continue to crumble. The prospects of war shines a light for economic recovery but what a lousy way to live and prosper (for some).
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