Japan, like China, remains a wild card when it comes to global risk sentiment. Japan’s economic indicators suggest the Bank of Japan may NOT pivot after all, giving way to a continued dovish stance. I’ve warned that a reversal of the carry trade on Bank of Japan tightening could spark a global margin call, and I still think this is a distinct possibility.
But for now, it’s clear that inflation data in Japan might delay that.
Inflation is a critical indicator that central banks monitor to adjust monetary policy. In Japan’s case, the Tokyo core Consumer Price Index (CPI), which is a measure of inflation, has been on a downward trend. Notably, it’s threatening to dip below the significant 2% level.
Why Shrinking Inflation in Japan Could Be a Red Flag
Why is the 2% target significant? Because it is widely regarded as a healthy rate of inflation, allowing for economic growth without eroding purchasing power materially. Central banks, including the Bank of Japan, often aim for this 2% rate to ensure price stability while fostering economic conditions conducive to employment and growth.
It’s not just the CPI, however. Japanese producer price inflation, which reflects the prices businesses receive for their goods, has hit a standstill, registering at 0% year over year. This stagnation is indicative of weak demand and pricing power among businesses, which is not supportive of a tightening monetary policy stance for now.
The Japanese 10-year yield, a key benchmark for long-term interest rates, is at 0.6%, well below the central bank’s informal “soft cap” of 1%. This suggests that investors expect continued easy monetary policy and low inflation. And so long as oil doesn’t surge, other inflationary forces likely won’t be enough to change very much, unless of course the yen plummets, forcing inflation to surge.
This remains the big question mark of course.
After a period of strengthening against the dollar in late 2023, the yen has been weakening in early 2024. Currency strength can influence inflation by affecting import prices, and thus, the Bank of Japan keeps a close watch on exchange rates. This results in a conundrum for the Bank of Japan. On one hand, the global narrative has largely been about central banks pulling back on the accommodative policies that were prevalent during the Covid-19 pandemic. On the other hand, Japan’s economic indicators do not align with this narrative.
The Bottom Line
The absence of sustained inflationary pressures in Japan makes it less likely for the central bank to move toward tightening monetary policy. This is contrary to past speculation that the Bank of Japan might tighten its policy around this time in 2024, assuming stable yet modest inflation. But should oil prices surge again and the yen plummet, the Bank of Japan would likely need to be restrictive to counter, and the narrative would flip yet again.
This is what makes this year so challenging for anyone looking to invest in Japan. The pivot back to dovishness has sparked a significant rally in Japanese equities. This market reaction underscores a continued appetite for risk that is buoyed by expectations of ongoing monetary support from the Bank of Japan. But this can change at a moment’s notice, making any confidence challenged.
Bottom line? I think both the Bank of Japan and investors continue to get whipsawed. The environment broadly remains high risk, and Japan may yet spark a global margin call should the yen really get out of control and the Bank of Japan not intervene to save it.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
