USD/JPY Report

Introduction:

The Bank of Japan stays on the path of monetary and fiscal easing. After recent inflation hikes and an introduction to a larger-than-expected stimulus package, the long-term effect of continuing to ease will be difficult for the BOJ. Authorities believe this is what is best for their economy at this time and have made it clear they are not afraid to pay the price of this in the future. The Federal Reserve continues to hike rates and in this process, they are putting themselves at risk to move into a deficit.

Easing Policy Measures:

After a unanimous decision made by the BOJ, short-term and 10Y targets remain unchanged at -0.1% and 0.0%. The future outlook for the BOJ continues to remain dovish and the central bank will likely continue to take additional easing measures. Additionally, the BOJ increased its inflation expectations for the next two years. As of October, the core inflation outlook has risen to 2.9% in FY22 compared to the 2.3% expectation in July. On the other hand, the inflation target for FY23 and FY24 is expected to drop to respectively 1.6%. This implies the BOJ believes inflation is only transitory and will likely restore itself to a stable level.

Fed Harming Themselves:

When rates were 0, the Fed had no problem paying participants who hold reserves or parked overnight cash. Now that the Fed approaches 5% rates, the amount they pay out will turn into a considerable amount of cash. The Fed is also losing a large amount on its bond holdings as they continue to drive up the rates. The Fed bond holdings have skyrocketed since the Financial Crisis in 08’ and the pandemic.

As the Fed pushes rates higher, the price of their bonds loses value. According to an outside source, in 2022 the estimated rolling total returns from the Fed’s holding of treasury bonds have reached respectively -14% so far in 2022. Regarding the Fed’s running payout on cash parked is approaching $250 billion by December. We must also consider that the Fed owns a 7.5 trillion dollar bond portfolio and if we take a simple back-of-the-envelope average coupon of 2%, that would provide an interest rate receipt of $150 billion in December.

Conclusion:

Both the BOJ and the FED are sticking to their monetary approach even as there are many disruptive factors involved. The BOJ shows no signs of hiking rates which is a dangerous approach because in a way they have tunnel vision. They have backed the 0 interest rate approach for roughly 20 years now which has not been an issue in the past because of low inflation numbers. The FED is starting to hint at a slowdown in early-mid 2023 but in the short term, we can expect a hawkish approach

-Chuck Kolar