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http://www.iht.com/articles/2006/03/08/business/bank.php

BOJ may vote to raise rates above zero: could spell trouble for other markets (like Treasuries), or not. But something to know about.
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Missed that, thank you Loki.

The fear now is that this flow could suddenly reverse if Japanese interest rates started to rise. This could spell trouble for overseas financial markets like those in New York and London because Japanese investors could start selling stock and bond holdings to repatriate their money.

IMHO this is healthy for both Japan and the US. If they move at a "measured" pace and telegraph their moves enough the markets will adapt smoothly. Its a good time to make the move while the US econ still has some legs left in this expansion, it will help balance out currency movements and thus keep exports flowing. Japan tends to like a weaker currency so they can keep the factories running and the exports shipping out.

Good article. Did an even handed job at pointing out the risk and ties of the money chain.

jack
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There are bigtime players who are borrowing money in Japan at 0% (essentially) and buying things like 10-yr Treasuries so they are getting something like 4.5% interest for free. This is called the carry trade. So if Janpan raises their rates, it could knock U.S. Treasuries for a loop.

brucedoe
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Bruce,

Correct, I'm not comfortable with phrases like "knocked for a loop". A quarter point move still makes this and nice 4.25% round trip. I'm not convinced that COJ will move as fast as our Fed has on this last round of bottom end lifting. They have been in an awkward monetary situation for a long time, long enough for it to be the norm. The best and the brightest know that the rate has to move up sometime but everyone is going to be nervous as the process moves upward on the cycle for the first time in a very long time.

Its kind of like jacking a house to move it. Its doable in fact people do it all the time but its different when its your house. Every house that gets jacked off its foundations makes awful poping and cracking sounds, they wobble and sway until they are set back down on cribbing. If its your house everyone one of these things feels worse to you.

In good form the BOJ is being pretty forthcoming
http://www.marketwatch.com/News/Story/Story.aspx?guid=%7BDB517E1E%2D1BAA%2D4ECB%2D9754%2D919452956D82%7D&siteid=myyahoo&dist=

ts focus in coming weeks will be to mop up excess liquidity in the money markets, seeking to lower the bank's current-account balance to 6 trillion yen from a range of 30 trillion to 35 trillion yen.

. . .

t said the liquidity shift would be "carried out over a period of a few months, taking full account of conditions in the short-term money market.

. . .
Fukui said the bank will seek price stability in the medium and long term by targeting an inflation rate between 0% and 2%.


Interestingly their stock market responded with a thumbs up.
http://www.marketwatch.com/tools/quotes/quotes.asp?sid=123712&siteid=myyahoo

a nice 1.4% move although I saw reports of +2% move, maybe my quick and dirty math is wrong or its after hours stuff. We'll see if there is follow through but current visibility suggests that the NIKKEI will continue its climb.

We should note that the COJ hasn't even moved interest rates yet. What they have done is begun the process of removing a bunch of money out of the money markets. In the US the Fed. would increase the size of reserves it requires banks to hold, thus taking the money out of circulation. I'm not sure exactly what the mechanics are in Japan but that is thier first step.

from the article quoated at the top
Ultimately, analysts believe the Bank of Japan will have to raise actual interest rates, but the first hikes are likely to be in the range of 10 to 12 basis points. And some suggest the first hike won't happen for up to a year.

This move demonstrates that they believe that there is enough infationary pressure in the system to withstand this deflationary move.
Reducing the amount of money in the system will increase demand for the money in circulation if we follow a straight forward supply and demand concept. This generally lowers interest rates by increasing prices. The COJ believes that their is enough excess in the system that the slow removal of the excess will not dramaticly effect interest rates.

To address your comment more specificly, this will have an effect on the "round tripping" that many, not just the Japanese, have done borrowing short from Japan and lending long in the US. The COJ is taking some of the money making that round trip off the table and thus less of it will funnel into US, GB and Euro debt. If I did the math right they are planning on pulling out of circulation the equivilent of 25 billion USD. 25 billion USD isn't huge within the scale of all the debt that this easy money policy enables. Within the US alone its spread across both Treasuries and Agency debt, two huge markets and some of it finds its way into the GB and Euro debt and I would assume some higher risk country debt as well.

This really is a baby step but a very important baby step for both Japan and the world debt markets.

jack
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So, I just saw a headline: US Stocks Lower In Spite of BOJ Move. I'm guessing at some point earlier it said, stocks higher because of, but missed it. Love this stuff.

I don't think the concern is with the direct impact of slight changes. One concern is that a change by BOJ in the amount of money it is printing will have a hyperbolic ripple effect if momentum traders and all that leveraged money starts trying to beat the rush to the exits.

The longer term issue fits a Catastrophe Theory mode: incremental changes can build up and lead to catastropic changes. Here the concern is that the US economy is a house of cards: we are living beyond our means, borrowing against inflated assets, workers competing against those with lower standards of living. BOJ has certainly been contributing to enabling this, since Japan gets a lot of the trade deficit, and although I agree it is a good thing for this addiction enabling to end, producing a soft landing may be wishful thinking.
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There are bigtime players who are borrowing money in Japan at 0% (essentially) and buying things like 10-yr Treasuries

_______________*,*_________________

Lets see if I remember how this goes?

This is one of the reasons for the varying exchange rate (yen v dollars) as one borrows the money in Japan at 0%, say 100,000,000 yen and then converts to dollars at 100 to 1 (117.3) so they invest 1,000,000 dollars and get 5% over a year. But they get 1,050,000 dollars and then have to go back to yen so the exchange rate in a year should be 105¥ to $1 (123)

If Japan raises their rates, it will slow the exchange rate change per time (rate rate??) Which could make the carry trade Bruce mentions vary profitable or if it doesn't work right very painful.


DrTarr
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Hi everyone,

Sorry to intrude but thought I would give it a whirl. The basic way to view this is with forward rates which imply what the future spot will be. The forward should be priced so that one can not conduct the sort of trade being mentioned.

Looking up the exchange rates

http://www.ozforex.com.au/cgi-bin/forwardRates.asp

The mid price for a 12 month forward is ~112.58 and using their current spot is ~ 118.195 Using the interest rate parity w/ 1 time period:

Forward/Spot = (1+ Japan's interest rate)/(1+ US interest rate)

112.58 / 118.195 = (1 + .00) / ( (1 + .05)

.9525 = .95238

Pretty close for rough numbers. Which is saying:

At time zero:

1) Borrow 100m Yen at 0% and exchange into $846,059 dollars at current spot of 118.195 Yen per Dollar.

2) Loan $846,059 dollars for a year at 5% in the US.

3) Sell a forward contract @ 112.58 exchange rate w/ 100m Yen notional

At year end:

4) Receive the loan plus interest $888,362

5) Deliver 100m Yen @ 112.58 which is the forward rate (ie expected spot rate) which costs you $888,257.

6) Profit is - ($888,362 - $888,257) - $105

7) Take your wife out for a nice dinner.

If you include transaction costs and don't use the midpoint price but use the ask price then this probably gets even closer to even and maybe you can afford an evening at McDonalds.

If you believe that the forward is mispriced or that the currencies and or interest rates are going to move in a manner that the forward isn't pricing then thats where a tactical bet can be placed and money to be made or lost. Otherwise their shouldn't be any money to be made due to interest rate parity and arbitrage.

Matthew
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But they get 1,050,000 dollars and then have to go back to yen so the exchange rate in a year should be 105¥ to $1 (123)

1. Maybe they don't go back to yen right away -- maybe they reinvest in dollars
2. They can hedge their risk at the start of the thing with a forward or futures contract.
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Forward/Spot = (1+ Japan's interest rate)/(1+ US interest rate)

Ya, what he said!!!

Maybe they don't go back to yen right away -- maybe they reinvest in dollars

Yes, but as the forward rate goes out it takes this into account. At some time the money is repatriated to Yen and the exchange rate will eat the difference in interest rate returns.

So for three years
(1+ Japan's interest rate)^3/(1+ US interest rate)^3




2. They can hedge their risk at the start of the thing with a forward or futures contract.

And the hedge they would get into right now is for interest rates in Japan at 0% and interest in the US at 5% all calculated out.

The risk that is hedged in this case is say for Disney Tokyo. They have a cash inflow of yen and they want dollars, so they will purchase forwards to ensure that they get the set amount of dollars for yens and thus they hedge away the exchange rate risk. If the exchange rate goes the other way, well Disney loses some extra take but that is the nature of insurance.

Thanks Rivet.

DrTarr






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Well, the market took the BOJ news with a yawn, but is reacting big time to latest jobs numbers.

If 10 year TIPS can stay at 2.25% or above come April auction, I'm in for sure, though it's too bad the auction is before the May 1 I-bond announcement.
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