Why Japan May Matter More Than Tapering

Asia Confidential's picture

The traditionally quiet period for markets in December is turning out to be not-so-quiet, thanks to a key meeting of the U.S. Federal Reserve starting December 17. The meeting will decide on whether a reduction in quantitative easing (QE) is necessary. Consequently, every economic data point up to the meeting is being analysed and over-analysed. But it does appear that the Fed seems committed to so-called tapering at some point soon and the odds are 50:50 that it'll pull the trigger in December.

A few weeks ago, I was asked for my 2014 global outlook by a large precious metals website and I told the editor that while tapering will be a key theme, Japan is likely to prove equally important if not more so. The editor was taken aback by this and I can understand why. But let me explain...

The Fed has been flagging tapering for some time and markets appear to have gotten used to the fact that it'll happen soon. In May, when Bernanke first hinted of tapering, markets freaked out as they assumed a rise in interest rates would come simultaneously. Since then, the Fed has been at pains to say that interest rates will stay low for several years to come while a wind down in QE occurs. Markets appear to have bought this line. They may continue to buy the line through 2014 and even 2015.

While the U.S. cuts back on stimulus, Japan is likely to move in the opposite direction, increasing its own stimulus very soon. That'll be on top of Japan's existing QE which is the equivalent of 3x that of the U.S. when compared to GDP. The reason for even more QE is that the grand experiment known as Abenomics, almost one year old, has been a failure. It hasn't lifted key components such as core inflation, wages or business spending.

Increased Japanese QE will mean a lower yen, potentially much lower. If right, that'll have significant consequences. Among other things, it'll increase the risks of exporting rivals fighting back by depreciating their own currencies and embracing a currency/trade war. Second, it's likely to raise the ire of exporting competitor, China, and raise already high tensions in the South China Sea. If more stimulus fails to lift the Japanese economy, Abe will be desperate to maintain his credibility and a fight with China could just suit his ends. Hence why Japan matters. Perhaps more than tapering.

To taper or not to taper?

It may be the time when the Fed stops with all the flirting and finally starts to cut bond purchases. Bond whiz, Bill Gross of Pimco, suggests there's a 50:50 chance, or even greater, of tapering this month. And he's probably right given the many hints from the Fed that it's ready to go down that path. If tapering does occur, markets will be assessing the potential time frame for a full wind-down of QE and the economic targets set by the Fed for that to happen.

To understand the potential consequences of tapering, let's do a quick recap of what QE is and what it's been trying to achieve. The Fed has put in place two key policies since the financial crisis:

  1. Lower short-term interest rates towards zero.
  2. Implement QE, involving the purchase of longer term bonds.

The Fed and other central banks have done this to achieve several ends:

  • Suppress bond yields and thereby interest rates (check).
  • Buying the bonds from banks and other institutions who can use that money to lend out and therefore stimulate the economy (hasn't happened).
  • The printed money also helping banks to repair their balance sheets, devastated by 2008 (check, at least in the U.S.)
  • Keeping short-term rates near zero means pitiful bank deposit rates and tempting depositors into higher yielding but higher risk investments (check).
  • Rising asset prices inducing the wealth effect, where people feel wealthier and start to spend again (minimal success, but let's wait and see).
  • Keeping interest rates below GDP rates, thereby reducing the developed world's large debt to GDP ratios (slow progress given sluggish GDP).

The Fed is now contemplating tapering as it sees a recovering economy and is worried about QE's stimulatory effects on asset prices. Tapering involves cutting back on the purchase of long-term bonds while keeping short-term interest rates near zero.

In essence, the Fed is saying: "Look everyone, we're going to keep short-term interest rates near zero for a very long time. We're resolute with this and hoping that cutting back on the buying of long-term bonds won't lead to a spike in long-term bond yields. Please, market, cooperate with us in achieving this aim."

The Fed knows markets largely control the long-term bond. It can't afford to lose control of the bond market as higher long-term bond yields would result in increased mortgage rates and rising government interest expenses. That outcome would be a disaster as consumers and governments simply wouldn't be able to cope with even a small spike in rates. And any hoped-for economic recovery would be over.

Key risks to the tapering strategy include a stronger-than-expected economic recovery or higher future inflation expectations, and the Fed moving too late to raise short-term rates. Alternatively, an economic recovery doesn't take place and more QE is needed to maintain current growth. Here, the Fed would lose immense credibility and may eventually lose control of the bond market as investors start to demand higher yields on government debt.

But these risks may not be short-term story if investors believe that tapering and rising rates don't go hand-in-hand.

Increased Japanese QE coming soon

On December 16 last year, Shinzo Abe came to power and promised the most audacious economic reforms in Japan since the 1930s in order to arrest a 23-year deflationary slump. Almost a year on, the reforms now known as Abenomics can be judged a failure. This failure may soon result in policies which could have a greater impact on markets in 2014 than the much talked about taper.

Initially Abenomics involved a strategy with the so-called three arrows. The first arrow was a dramatic expansion in the central bank's balance sheet to lift inflation to a 2% target rate. The second arrow involved a temporary fiscal support program. While the third was structural reform to the economy.

The first arrow came with much fanfare and resulted in a large depreciation of the yen. Yen devaluation wasn't a stated aim but was certainly a target given a lower currency is needed to lift inflation. The big problem is that inflation has risen for the wrong reasons via higher import costs. Core inflation is flat as wages have barely moved.

Japan CPI & balance sheet

The second arrow was implemented while the third arrow largely hasn't been fired. The market has been disappointed with the latter as it knows economic reform is needed for stronger and sustainable growth. Abe has resisted change on this front given the entrenched interests against reform.

A fourth arrow has been fired, though, in the form of an increased consumption tax. The tax will increase from 5% to 8% in April next year. This is necessary to raise government revenues given Japan's unsustainable budgetary position where government debt is 20x government revenues. The problem is that the tax will depress spending and cut GDP growth by an estimated 2% next year. To partially compensate for this, Abe has promised corporate tax relief and infrastructure spending of 5 trillion yen, equivalent to 1% of GDP. In other words, more stimulus to partially offset the impact from rising taxes.

Given the failure of Abenomics to lift core inflation or wages, you can soon expect even more stimulus on top of the 290 trillion yen already planned between now and end-2014. And this is likely to result in a much weaker yen, for the following reasons:

  • To reach a targeted 2% annual inflation rate requires the yen to depreciate by around 15% per year. That translates into a +115 yen/dollar rate by the end of next year.
  • If U.S. tapering occurs, that will widen the yield differentials between U.S. and Japanese bonds even further. Those yield differentials currently point to fair value of 115-120 yen/dollar rate.

Japan US yield differentials

  • More QE should result in more money heading offshore and a subsequent weakening of the yen.
Impact on the rest of the world

If a much lower yen is on the cards, it'll have the following consequences:

  • Japan will export even more deflation to the world when it least needs it. By this I mean that a lower yen allows Japanese exporters to price their products more competitively vis-vis other exporters. This would raise already heightened global deflationary risks.
  • It'll put other exporting powerhouses, such as Germany, China and South Korea, in a less competitive position, increasing the odds of a backlash via currency war. The yen at 115 or 120/dollar would change the ballgame and increase the risks of this occurring.
  • Any currency war risks a trade war. Historically, trade wars reduce global trade, sometimes significantly.
  • Putting China in a weakened exporting position will possibly increase tensions in the South China Sea. Tensions are already high and a lower yen won't help the cause.
  • You don't have to have a wild imagination to see that if Japan's experiment doesn't help lift inflation and the economy, a desperate, nationalist Prime Minister may just be more inclined to take the fight up to China.

The above analysis could well turn out to be incorrect. Perhaps Japan holds off on stimulus. Or it increases QE but combines it with meaningful structural reform.

Maybe. Whichever way Asia Confidential looks at it though, a substantially lower yen would seem to be something you can almost take to the bank. And the implications of that being the case are worth thinking about as we head into 2014.

This post was originally published at Asia Confidential:

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poldark's picture

There will be no tapering until there is significant inflation. Then the brown stuff will hit the air moving device.

moneybots's picture

"The printed money also helping banks to repair their balance sheets, devastated by 2008 (check, at least in the U.S.)"


The problem with that is that the FED is hurting its own balance sheet in order to do that.  The FED is leveraged up over 50 to 1.  A 2% loss bankrupts.



moneybots's picture

"Japan's existing QE which is the equivalent of 3x that of the U.S. when compared to GDP. The reason for even more QE is that the grand experiment known as Abenomics, almost one year old, has been a failure"


Bernanke wrote in 1988 that QE doesn't work.  QE isn't an experiment when it is already KNOWN that it doesn't work.

Abenomic QE is 3 times that of the FED, compared to GDP, and even that is failing.  Bigger obviously isn't better.  When it doesn't work to begin with, it doesn't matter how large it is. 

Abenomic QE proves Krugman wrong.  The problem isn't not enough stimulus.

GreatUncle's picture

Mathematically work = income right?

Not enough work = low income. Print as much as you want in such a system only 2 courses of action possibly work the last one don't.

1.) allow people to earn it through work.

2.) hand it out for free.

3.) hand it to a bank to gather dust.

Japan is a prime example of what? Remember 70-80's Japan was the regarded as SO EFFICIENT ECONOMICALLY in terms of production per person. 20 years ago all the little robots you seen, were thought of, dreamed of and stamped made in Japan.

Leave you to speculate ... Think 1%, rope, tall tree but never for greed. The concept of money, what it is, how it is used for power are all coming into focus through the current economic situation which has sweet fuck all to do with money but the productive capabilitiy and efficiency which means we have NO WORK FOR YOU!

Duude's picture

I don't know why the Fed feels it critiical to claim they aren't going to raise interest rates anytime soon even as they plan on tapering. Yes, they won't be raising the fed funds nor the discount rate. I believe that. But the tapering itself has a greater effect on interest rates anyway. Its the tapering of artificial support of current low rates on both treasuries and mbs. Mortgage rates will rise that is assured, and with homebuilding at 1/3 the rate of the last 50 years we can expect the housing "boom" will peter out into another asset bubble to pop. Not disagreeing with the need to taper as I never supported QE in the first place, just the misinformation emanating out of the Fed. 

doctor10's picture

Somebody, someday is GOING to detonate the US Bond Market. In the famous words of Willy Sutton-"that's where the money is"


The only issue is whether it is first more profitable to do Japan

TyrannoSoros Wrecks's picture

What's all this shit about tapering? Are there still people who actually think they will ever taper? The State Dept just spent $1 million for a small pile bricks slapped together by some faggot "artist".

You can't pay for million-dollar fag bricks if you taper.
Like whats-his-name said, they'll be printing a trillion $$$ per month soon enough.

doctor10's picture

"Fag Bricks"-hehheh-sounds like a "payoff" to someone's "boyfriend"

Platinum's picture

Fag Bricks is our secret word!


Scream REAL loud!



ZH comments are better entertainment for the inebriated than anything Hollyweird puts out.



Peter Pan's picture

"Faggot bricks" as you call them might not be the best choice, but they are a lot better choice than Iraq, Afghanistan and propping up banks.

TyrannoSoros Wrecks's picture

Yeah but they're doing both. They didn't cut $1 million from some other program to buy that big pile of gayness.

WallowaMountainMan's picture

"The printed money also helping banks to repair their balance sheets, devastated by 2008 (check, at least in the U.S.)"



a question if i may. the fed is buying 45 b a month of mbs's. i assume they come from u.s. banks, but i am not sure ( i would , however, wager a pence or two that the 45b being bought is not worth 45b, not even close).

what do you think the 45b is really worth?



mick_richfield's picture

It isn't worth shit.


Nobody knows how to read the Fed.  Why do so many people (like the author of this article) take them at their word?  When they say "We hope to be able to taper soon" do you really think that means that they hope to be able to taper soon?

I guess there's a reason why they call us 'cattle'.  I'm looking for a way outta this fuckin feedlot.

andrewp111's picture

Just in 2002 the JPY was 130 to the dollar, and was over 140 per dollar in 1996. It was even 230/$ back in 1985. What is the big deal if the JPY falls? Maybe Japan will have to restart all its nuclear reactors in order to eat, but sx what?

moneybots's picture

"Just in 2002 the JPY was 130 to the dollar, and was over 140 per dollar in 1996. It was even 230/$ back in 1985. What is the big deal if the JPY falls"


Like, what is the big deal if 91 million Americans are not employed?

TNTARG's picture
BBC: Work at Fukushima Unit 4 a “distraction”; The “real nightmare” is coming from 3 molten cores — NYTimes: Melted fuel is “all over the place… First goal is simply to stop uncontrolled releases of radioactive material”



Death it's what's coming from Japan. Worldwide, I'm afraid.


Pejorative Requiem's picture

"The Fed is now contemplating tapering as it sees a recovering economy and is worried about QE's stimulatory effects on asset prices. Tapering involves cutting back on the purchase of long-term bonds while keeping short-term interest rates near zero."

The Fed is considering tapering? Tapering what? Yellen is a true believer; though a shift in the means of continuing inflationary policy may benefit a different cadre after she's installed. And who can blame Japan, or anyone else, for pursuing inflationary policy when TPTB see deflation as 1) more likely than inflation and 2) exponentially worse in consequence than inflation.

The grand experiment continues.

mendolover's picture

Aging population is also a big deal over there.  Japan now sells more adult diapers than baby diapers.

Lets Buy The Dip's picture

can you say chop suey min!? Getting old sucks, but the market never dies. 

Have a look at the monthly chart of the SPX here => bit.ly/1bocbZf

To me it seems like a safe place to put money, 2013 on the US market has been horrific for bears, and year every few weeks they call a top. 

anyone see a pattern there? no?

SAT 800's picture

A safe place to put money? Because it went up last year? What infantile drivel.

sunnyside's picture

That'll teach 'em for bombing Pearl Harbor.

Peter Pan's picture

All this talk about tapering and QE is total bullshit. Unless large parcels of unsustainable and unpayable debt are destroyed, we will end up destroying ourselves instead.

Low interest rates are the basis of our economic demise and the sooner the market is allowed to re-assert itself, the sooner we can steer to a sustainable paradigm.


vote_libertarian_party's picture

What does Japan export?  Some cars?  Most of the US purchases are manufactured here now.

Not Too Important's picture

"What does Japan export?"

1. Massive quantities of lethal radiation. Metric tons of radioactive food that they won't even feed their own - who are dying in record numbers - to countries either paid off to take it and feed it to their poor, or to countries that have massively relaxed their food maximum radiation numbers (hint, hint)

Japan will be dead in two years. How much quicker their currency will collapse is open to speculation.

2. Then follow the jetstream.

The Japanese .gov is worse now than the '30's, with worse weapons. If they and China get into a pissing contest with them, see #2 above.

OneTinSoldier66's picture

"The Fed seems committed to so-called tapering at some point soon and the odds are 50:50"


Seems pretty committed to me. Place yer bets, and double-down!

Garth's picture

A decoded Fed statement on tapering:

We are currently buying 85B of bonds each month thus holding interest
rates down.  We are going to decrease the size of our purchases, however
interest rates are not going to rise.

It's amazing that this contradiction isn't pointed out each time tapering
and low interest rates is mentioned.

Don't listen to the stories, watch the action:

a. Congress is deficit spending +1T/year

b. Treasury has to sell +1T/year of new securities as well as roll the existing debt

c. Fed has to print to buy them since there aren't any others

d. Some of the existing debt isn't rolling so the Fed has to buy that too...



SAT 800's picture

Yes, it's really not nuclear physics. Supply and Demand are real. Reduce the demand and maintain the supply and the price goes down; which in Bond World, is the same as saying the yield, or effective coupon rate, went up. One interesting trade is to short the 30yr. Bond on the CME; it's a cash settlement trade. Have a one year time-line and don't over-buy. Roll over the position as necessary; the concept being to participate in a long term trend. The 30yr. made it's top a couple of years ago. You can short it right where it sits and just ignore it if you have some free equity in your account to take care of temporary up-ticks. After the downwave is established you  can pyramid. This is one of those trades that has a 90% probability of being very profitable; and it could turn into a thousand per cent gain.

kaiserhoff's picture

Agreed with most of the above.  The key here is the long/short split.

The Fed has many ways, some of them stupid, to keep short rates nailed to the floor.  Bond buying has been their only effective tool with long rates, here the 10 year.

If they follow through with a taper, mortgages will explode, FHA, pension funds, and insurance pools take massive gas, and housing..., wait for the dead cat bounce.


disabledvet's picture

by saying "Taper" the Fed destroyed the functionality of the QE. It no longer does anything now. Winding it down will only make the Depression we're in obvious. There is no longer any effect to having it in place. The question now becomes "just how massive will the double dip recession be."

kaiserhoff's picture

Good point.  All markets, to the extent that any are left, are forward looking.

By saying taper, the Fed acknowledged the box they are in, and that they would like to get out of it.  Good luck with that.

TrustWho's picture
We are about to witness the problem with Fed TRANSPARENCY..... Well, here we are at 7.0% unemployment rate. The Fed is still executing the QE program at the maximum rate, to date, of $85 billion per month. The Honorable Federal Reserve Chairman, Ben Bernanke stated in the June 19th, 2013 press conference: "...when asset purchases ultimately come to an end the unemployment rate would likely be in the vicinity of 7%" The Fed should have reduced QE in September. The Fed is scared to death about tapering consequencies, the Fed is composed of PhD COWARDS, so how will they lie next?
GreatUncle's picture

The unemployment level may be 7% as stated in government statistics.

The inactive, of age not in the workforce is ?? WAY HIGHER!

FED 2FACE here ... From the bright side we have an unemployment rate of 7% but on the darkside the government statisitics are so manipulated down for all those not in the workforce to make the initial calculation of 7% not credible. TO PREACH FORWARD GUIDANCE VALUES LEAVES YOU INJ THIS POSITION.

Now the calaculation was some clever economics person with guess a doctorate who had calculated way back mathematically that 7% of the population being unemploymed is an acceptable figure for a sustainable economy. THIS BIT IS PROBABLY RIGHT, BUT ALL THOSE BEING KEPT OF THE UNEMPLOYMENT TRASHED IT!


If anything they need to revise how unemployment is reported, if you are of age and not in the workforce you are unemployed NO IFS NO BUTS NO NOTHING even if you do not get a penny.

Then you might want to do the calculation again and try using the greater input figure this time chances are you will find the abilitiy to taper gets alot harder and when you do reckon won't be long before the un-taper is back.

AngelEyes00's picture

I agree, transparency is the right word.  The Fed are either good to their word or they are not, because as you stated 7% unemployment was the threshold by which they supposedly would discern a healthy economy and taper.  So if they do not we can surmise they are stuck with no alternative and the 7% figure was just an excuse (they probably thought would not happen anytime soon).

My opinion is they will decide to continue QE as is, and Yellen will raise QE to over a 100 billion a month to continue to monetize the debt.  She will follow Abe's motus apparandi.  When that happens we'll know we're really screwed because end game of the USD will be sealed just as it is for the Yen. 

Greenskeeper_Carl's picture

great pic name by the way, love that movie


AngelEyes00's picture

Thanks Greenskeeper.  I bet if someone sold a pocket watch like his that played that same tune it would sell pretty good. 

Jackfish's picture

Someone does sell exactly that, a copy of the watch which plays the correct tune



Greenskeeper_Carl's picture

You are probably right about the 7% thing just being an excuse. But the not thinking it would happen anytime soon could kinda go either way. The people at the top know all these BLS stats are bogus just as much as we do. Therefor, they are all liars. ANd they know that an inevitable consequence of a horribly deteriortating economy/welfare state combo is that people will say fuck it and stop even bothering to look for work, so from that angle, 7 % and even lower is possible, as long as we keep on not counting these people in the number. The intersting part, to me, is that by not tapering at 7%, they are pretty much admitting( to the keen observer at least) that this number is meaningless becasue it is a lie, and the econmoy still suck even with the oh-so-important unemployment coming down

GreatUncle's picture

In an industrial society everything costs implies you need an income to pay bills therefore those in the workforce have an income in some form to pay bills.

The poor form of tax evasion and nice if you can choose that position.

Kiwi Pete's picture

Why not just let the bogus 7% unemployment rate rise back up to it's true level. The original aim of bringing it down to 7% was to get Obama re-elected. The new aim is continued QE so let it rise. If it rose to a more realistic 11% you could even justify QE of $100bil/month which is even better. win/win!


brettd's picture

The 7% target was Ben.

Janet will change to "revisit" and change to a 6% target.

Lube the presses!

rp1's picture

This is all part of a well established pattern that goes something like this:

"Fed blows bubble" -> "Fed denies bubble" -> "Fed feeds everyone bullshit" -> "Fed believes it's own bullshit" -> "Fed blows everything up"

Solarman's picture

Traders will not hope, they will wait and see who steps up and buys bonds first.  They will test the Fed's resolve.  If I was a large hedge fund and not in bonds now, I may sell into a selloff to cause a panic in order to position myself to join the Fed when they must jump in.

kaiserhoff's picture

It's a little worse than that.

If you are in a defined contribution pension plan, you have a choice, stocks or bonds.

How would you like your stocks or bonds, or bonds or stocks.  Yuck.  There are buyers, but more or less forced.

shinyindallas's picture

It's much worse then that.

Your choice is a stock fund or a bond fund. Which is really not a choice of stock or bonds, it is a choice of fund managers.

Deo vindice's picture

Race to the bottom.

It is now which rock can fall the furthest the fastest.

mess nonster's picture

...and Galileo and physics tells us that the race will be a tie. After all it's not the fall that kills you, its the sudden stop at the end.

rp1's picture

Long term chart of EWJ:  http://imgur.com/mRLwHVt   The 06-07 trend line has been broken and is now support.  The big line is from 2000.  It can either break that now (you never know) or it might follow the 06-07 line down into 2016.  10 year returns could be the same either way.