Defending the Yen

Japan has always been different. In 1945 the country was devastated by WWII, but by 1989, it was the second largest economy in the world. The collapse in real estate prices brought deflation and recession, and the Nikkei spent almost 3 decades until it could regain the highs of 1989. Then came the debt. Massive 250% of GDP. The monetización of debt followed. The BoJ owns, still today, 50% of the outstanding government debt. To do that, it printed money (yen) and used it to buy the debt. Left pocket issues, right pocket buys. The yen went from 133 vs the USD in 1989, to 76 during the GFC (2008), to the current 156. Now the government is trying to let the long term rates find equilibrium. In other words, long term yields are rising, and so are the country’s financing costs. The market thinks they will need to print more money to avoid the collapse of their debt, and the west is front running by borrowing money in Yen (thinking it will weaken more), to buy US treasuries or Mexican Ceres or else. The BoJ has painted a red line. It will not let the Yen weaken beyond 160 vs the dollar. Look at the top chart below. The green shades are interventions: sell dollars to buy Yen. This causes Yen carry trade partial unwinds, and then the story repeats. But the money spent defending the currency, is not recovered. In the bottom chart, you can see the amount of money the Japanese government has spent during the last 4 years defending the Yen. $200Bn. And that is done by selling US Assets, mostly treasuries. Japan is the biggest holder of U.S. debt. It’s the US biggest creditor. If Japan needs to increase the defense of the Yen, they will need to sell more USTs. And there lies the problem. The U.S. is at a jucture where long term yield increases will force the Fed (with Mr Warsh at the reins) to monetize debt. That will weaken the dollar vs the Yen, and may force the yen carry trade to fully unwind. And part of the US equity run up is backed by the yen carry trade. That’s the connection.

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