Is An 18% JPY Devaluation The 'Best-Case' Scenario For Abe's 'New' Japan?

Tyler Durden's picture

The JPY dropped 1.3% against the USD this week for a greater-than-6% drop since its late-September highs as it appears the market is content pricing Abe's dream of a higher inflation-expectation through the currency devaluation route (and not - for now - through nominal bond yields - implicitly signaling 'real' deflationary expectations). In a 'normal' environment, Barclays quantified the impact of a 1ppt shift in inflation expectations from 1% to 2% will create a 'permanent inflation tax' of around 18% (which will be shared between JPY and JGB channels). However, as we discussed in detail in March (and Kyle Bass confirmed and extended recently), the current 'Rubicon-crossing' nature of Japan's trade balance and debt-load (interest-expense-constraint) mean things could become highly unstable and contagious in a hurry. When the upside of your policy plans is an 18% loss of global purchasing power, we hope Abe knows what he is doing (but suspect not).



Barclays: How low can the yen go?

A revision of the BoJ inflation target could pose a greater downside risk to the value of the JPY than most market participants think. The LDP, which is likely to lead the new government after the Japanese elections, has argued that it would revise the inflation target to 2% from the still unmet target of 1%. Discussions are likely to remain lively until a new government is confronted with the actual perils of reality, but we and many market participants believe politicians patience with the central bank may be running out.


The timing of the more aggressive stance to target higher inflation is likely to depend on global factors as well, but the stars appear to be aligning for the changes to take place in the early part of 2013. The pursuit of higher inflation targets may have a destabilizing effect on domestic yield curves. The added volatility that may be introduced in the curve may well delay the initiative, if it were to occur. For these reasons, we expect the process to be gradual and to occur once global risks for markets begin to dissipate.


That being said, a window of opportunity may open up as early as the first half of 2013, with a diminishing of fiscal cliff risks in the US and an initiation of the OMT program in Europe. Then, the question remains: how much can the JPY depreciate in response to the new inflation-targeting regime.


The inflation tax


A back-of-the-envelope calculation suggests the upward move in USD/JPY can be surprisingly steep in response to higher inflation expectations. The Japan sovereign linkers curve goes up to 2018, six years into the future, and liquidity is rather scarce, which means the information on inflation expectations conveyed by the implied breakeven curve is rather poor. Still, 6y breakeven inflation implied by linkers is currently at around 60bp.


Instead, let us assume that inflation expectations are actually already running at about 1%, and that the government will manage to implement changes to force the central bank to successfully target 2% inflation. To be conservative in our estimates, we would measure success as the public fully buying into the 2% target, from a prevailing, de facto 1% inflation target. We note that this represents a lower bound in the size of the shift, since current inflation expectations are running lower than 1%.


An estimate of the theoretical impact 1% permanent shock to inflation expectations can be computed by discounting the government's expected revenues from seniorage on each yen outstanding (the right to tax those holding yen). Assuming seniorage is already 1% a year, we estimate the difference in government revenues for permanently raising the inflation tax to 2%. Revenues are 1% in the first year, and then 1% of the leftover value of the yen two years from now, equivalent to 98 cents in real terms (given the 2 percent inflation tax), and then 1% of the remaining value by the third year, equivalent to 0.98*0.98 =0.98^2 and so on.


Following this logic, we then discount all these government cash flows by using the actual government yield curve (as a proxy for a discount rate at different maturities, Figure 1).



The NPV of all these cash flows give us a difference in fiscal revenues between a 2% and a 1% permanent inflation tax equal to 18%.


JPY on the move?


This NPV reduction would affect market prices of both JGBs and the JPY. There are potentially two limiting cases that can be considered for the impact of the policy change.

  • In the first one, JGBs price in the higher inflation expectations entirely through an upward shift of the curve. In this case, real interest rates remain where they are and the JPY is largely unaffected by the impact of the higher inflation target, which is then compensated by higher nominal yields (perfectly netting the tax off). In this case, the JPY remains unchanged and nominal bond prices in domestic currency drop in value, depending on duration, to accommodate the 100bp uniform selloff in nominal rates (Figure 1).
  • And the other limiting case is one in which all of the burden of adjustment is borne by the JPY. This would happen if the central bank aims to bolster growth by pushing real rates lower and achieves this by keeping JGBs from selling off by using tools such as increased asset purchases. In this case, where the term structure of nominal interest rates remains unchanged, the JPY should then depreciate by 18% in response to a permanent change of 1% in inflation expectations to 2% from 1%.

Likely, the final burden of higher inflation expectations will be shared by bond prices and the JPY. While initially the central bank may attempt to keep the nominal yield curve steady, eventually we expect activity and inflation expectations to react, as a cheaper JPY helps economic activity. How much is shared by bonds and by the currency will ultimately depend on how fast activity reacts. The slower the reaction, the bigger the burden that will fall on the JPY.


We would expect considerable uncertainty around the channel through which the higher inflation target is priced. For the time being, it appears that the market is content selling the JPY and buying JGBs – suggesting that the JPY weakness may be the primary outcome of the policy move. The longer-term impact is somewhat clearer cut, higher inflation should put downward pressure on the value of the JPY versus all other currencies.

And the alternate - non-normal 'rational' world view that in fact is more likely to occur should be read here, and why rates cannot be allowed to rise...

And just to show the sensitivity of the world's most indebted nation to interest rates, here again is Andy:

Even though the yield on 10-year Japanese Government Bonds (JGB) is only 1 percent, the interest expense is expected to top 22.3 trillion yen in the fiscal year that begins next month. This is one-quarter of the general account budget. If the bond yield rises to 2 percent, the interest expense would surpass the total expected tax revenue of 42.3 trillion yen.

Yup: a mere "surge" in interest rates to a whopping 2.00% will destroy the Japanese economy.


Be Careful what you wish for Mr. Abe.

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Aziz's picture

Hey! This new Japan seems a lot like the old Japan.

knukles's picture

You didn't devalue that yourself.

max2205's picture

Makes for cheaper nuclear clean up?

IMA5U's picture

So is this now the most crowded hedge fund hate trade on Wall Street?

THE DORK OF CORK's picture

A devaluation means they must light up those nuclear fires again.

No more cheap LNG

bank guy in Brussels's picture

Forgot the exact article, but ZeroHedge ran a rather good technical piece about how, Kyle Bass' bet notwithstanding -

Japan's can-kicking ability could actually last until about 2018-2020 or so, given various devious techniques and internal Japanese factors that could be used to continually suppress yields and keep the whole Yen-bond-Ponzi going

Wish I had book-marked the article ... It is continually damn impressive as to what these Central Banks can do with various shady measures

Like many of us in banking thought the 2008 blow-up would have happened 5 years earlier ...

Japan has made many a person broke over the years, betting against them ... One day their game will end but it still may be too late for Kyle Bass

Tinky's picture

The difference, however, between even just a few years ago and today, is that the system is now significantly more fragile. That problem is compounded by increasing likelihood that a black swan event (or events) will trigger either a major crisis, or a series of cascading lesser crises leading to a crash.

As Talib has pointed out, "Complex systems that have artificially suppressed volatility tend to become extremely fragile...". It should go without saying that the longer volatility is artifically surpressed, the more unstable the system becomes.

Japan was able to extend its ultimately untenable situation for a long period time, but did so mostly prior to the massive increase in instability that the world now faces.

My money is on Bass.

Yen Cross's picture

 I'm thinking 10 years down the road to " BoJ/MoF" repayment schemes...

  250%GDP and counting. The "¥" door is already closing...  Japan is 90% energy "deficient"...

  Greece on " good will".

Aurora Ex Machina's picture

Go long nappy production:

In two decades from now, seniors will outnumber children under 15 by nearly four to one. The situation is now so critical that adult nappies outsell baby nappies in the country.

1947 - 2.7  million births; 2011 - 1.057 million births

1947 population 78 million; 2011 - 128 million.

The study, published by Japan’s Ministry of Health, found that a third of men aged 16-19 said they “detested” or “had no interest in” sex, an increase on the results of a similar survey conducted 2 years ago.(English commentary) ~ And yes, the irony of all the adverts being hyper-sexualised doll-like anime figures is not lost on anyone.

nevket240's picture

Japans regression to its fuedal past is well underway.

The Black Swan for Asia will be the demise of the present King of Thailand. When he goes up in smoke so does Thailand. And it won't be all that long.


ReptilianSlaveMaster's picture

LOL This author is a moron and those who believe him are even dumber - JPY commiting serial devaluation is laughable, look at the last 6 years of the FXY idiots - Deflation is their problem

Schmuck Raker's picture

I fail to see the last 6 years, or even 10, as some sort of talisman to ensure the future mirrors the past.

That's 7 minutes of Kyle Bass' clear thought. Things do occasionally change...

ReptilianSlaveMaster's picture

Enough with the space time continuum Cheech.

FXY tracking ETF has only existed for 6 years dumb fuck. The authors thesis was based on 3 months of price action, maybe you woulod know that had you remembered anything you read. I told you dumb fucks to looks at the last decade yet you pass it up with  a single philosophical comment. All the thumbs down on my comment just proves how everyone who uses ZeroHedge is just as retarded as the CNBC talking heads they mock.

- too much bias not enough thought

Fact is Japanese yen is up 100% since the beginning of 2000 while all other currencies are down in the last decade.. Wake up idiot Japan is an export company - they need a weak yen, the reason their companies are going down the ugtter is because the yen has been on fire since Japan's debt spiraled out of control, explain that one for me you dickless freaks of nature

Schmuck Raker's picture

Soooo, YOU may make references back ten years, but mine don't apply?

When you mentioned FXY you were NOT talking about the Yen? Just an ETF?

"Fact is Japanese yen is up 100% since the beginning of 2000 while all other currencies are down in the last decade."

"Fact is..."? You refute me by confirming my statement, that you consider a 'pass'.....? [sigh]

Whatever. You got me. I give up.

willwork4food's picture

I don't blame you. I'm not the best speller on my block, but damn dude, got a spell check?

Dickless freaks of nature?? You pissed you're bleeding over @ FX?

Snoopy the Economist's picture

Hey reptile-man

Every country needs a weak currency to increase exports. Please take your POS ass away and stop commenting here - you ruin the atmosphere.

EARLPEARL's picture

europe will implode before japan so hurry to short jgb

bushwarcrime's picture

A 2% rise on bond yields will destroy the US, Euro, and JPN along with afew others.  This will not be allowed to happen.  Currency devaluation is and will continue to roll on faster and faster.  

willwork4food's picture real assets keep rising and rising. Doesn't matter if you don't have a yob if the cost of bread is a day's wage.

Personally I still call that hyper inflation.

lasvegaspersona's picture

balance sheets?...the world don't need no stinkin' balance sheets...just print one will notice...Zimbabwe is still getting away with it..............aren't they....?

northerngirl's picture

Unfortunately, the print, print, print, model has fooled the majority of people into thinking everything is fine.   

Miles Kendig's picture

Looks like Mr. Abe wants to put the Japanese economy more firmly yet on the WaMu Pick-A-Pay NINJA mortgage product

WhiteNight123129's picture


How much is the jump in Energy price (due to Fukushima) is responsible for the terms of trade deterioration?

Are there any plans on the horizon which could lower back hte cost of energy in Japan?

What happens to the stock market in Japan in case you unclog deflation (i.e. 1933 and 2009) likely huge rally.

What would be the impact of inflation on Japanese firms using cash to buy overseas but then overseas hedge fund chasing a stock market rally in Japan?

Declining long bond yield are deflationary, so by buying long bonds, this would perpetuate deflation. Could the Japanese gov err and not let the long bond yield rise very very slowly?

Finally. Consumers so far remove some circulation medium (yen) to convert those into monied capital (JGBs). Should they lose appetite for GJBs and the safe heaven status of those, wouldn t they sell their bonds for circulation medium (Yen) and spend them instead? Japanese Central banlk would buy those and create circulation medium.

At that point the old generations sell their bonds because they are not ~safe~ anymore and give to their kids who spend. At that point, because the young spend those, the nominal circulation goes up sharply, but wouldn t the nominal taxes revenues go up in that scenario?

It is hard to conceive inflation without consumer spending in the Japanese case because there are savings to spend. The defection of the consumers from GJBs would have to go somewhere.

For the consumer who considers the GJBs as savings it would go into consumption. For Japanese investor who considers the GJBs as ~investment~ it might go into the Equities, and since the consumer are forced to spend, it might be a well ordained ~coincidence~.... which would boost consumption stocks in Japan.

CONCLUSION> Is the move on Japan toward inflation much more rewarding by buying out of the money stock options like Hugh Hendry mentioned? This way to play it from Hugh Hendry sounds smarter to me than Kyle Bass because more wicked and convoluted.



cranky-old-geezer's picture



If our govt could brainwash the sheeple masses buying govt debt is a patriotic / cultural duty, they could get away with 250% debt/gdp like Japan does.

...welllll... that and having a nice trade surplus ...which is winding down now thanks to Fukushima, buying radioactive Kubota tractors doesn't appeal to most folks.

People like Burris made boatloads of money on the housing collapse not by watching charts, but by watching demographic trends (which charts don't show).  Chart watchers were caught flat-footed when the housing market collapsed.  Nobody saw it coming in charts.

Japan's govt debt bubble won't burst suddenly, but it will slowly deflate from patriotic & cultural changes.  Young Japanese don't share the strong patriotic & cultural views of older Japanese.  They won't load up on govt bonds and when govt bonds are passed down to them they'll be sold for spendable cash. 

When that rising tide of redeemed bonds comes on the market, BOJ will print and buy them up.  It will inflate the money supply way faster than their Fukushima-induced shrinking GDP, causing the Yen to drop way faster, and Japan will be in the same situation as America, hyperinflation.

None of that developing reality is shown in charts, and chart watchers will be caught flat-footed again, aka losers.

Poetic injustice's picture

Have you been inside of couple of Japanese houses?
They look practically empty.

Also their food habits are much more healthy.
You can't reach in USA all that, unless mentally you become Japanese.

Yen Cross's picture

 Been grinding through yen charts all morning...  I wouldn't be surprised to see usd/jpy @ 90 in February. Here's the pot sticker...

 That would cause massive appreciation in the crosses. That inflation will probably lead to deflation in the small E/M AND Asian markets. Can you imagine  aud/usd @ 1.10-1.15? eur/jpy at 1.27-1.30? Something/somehow, has to be reallocated. That's massive stagflation!

GFORCE's picture

We do love a Rubicon reference.

dinastar2's picture

The JGB are almost exclusively sold to the japanese citizens.If tje Jpan govt wants to attact foreign investors - it must serve decent interest rate - at least 0,75% like Europe , this this increase in the yield will bring down the price of JPGovt bonds, and decrese the devaluation of the yen.

The other way to stimulate is by putting all the burden on the JPY currency, then, you'll see it running to 100 Y / US$, wich is safer for stimulating exports