Japan has a special place in the world’s economy and financial markets. After the Second World War, its economy flourished, becoming one of the largest ones globally. For years, it was the envy of many nations – until demographics and the closed culture turned into more than just a regular problem.
Its currency, the JPY, is one of the most traded currencies on the international markets and Bank of Japan (BOJ), one of the two major central banks that does not have an inflation-targeting mandate (besides the Fed in the United States.
The problem comes from the self-fulfilling aspect of inflation expectations. For decades, Japan fought deflationary conditions, so economic agents do not believe anymore in BOJ’s ability to create inflation – hence, the mandate differs from the rest of the other central banks in the developed world.
Japan’s Response to the Coronavirus Crisis
Due to the unique conditions it faces (older population and closed culture), BOJ is one of the central banks that has always looked at innovative policy changes. If it needed to cut rates below zero, it did so. If it needed to run quantitative easing, it did so, more than any other country in the world. Moreover, it turned into a great defender of the yield curve control, something considered impossible to achieve by many economists.
The recent response to the health crisis, once again, has shown Japan answering with full monetary and fiscal power. In May, the Japanese government approved JPY117 trillion, the equivalent of approximately 21% of Japan’s GDP as an economic rescue package. In USD terms, that is a little over one trillion American dollars.
Yet this is the second package in response to the coronavirus. The first one, in April, had approximately the same size.
On top of this, the BOJ unleashed its monetary policy easing too. It plans to aggressively buy from the new-to-be-issued government bonds and treasury bills worth over $2 trillion. Together, the combined fiscal and monetary packages make it the world’s largest stimulus in response to the economic shock created by the coronavirus.
For investors, the BOJ measures matter as both equity and currency traders keep an eye on the JPY. Because of its low interest rate, US investors long-favored borrowing in JPY to buy US stocks (risk-on movement, higher USDJPY), while reversing the process when booking profits or selling stocks.
This time both the Fed and BOJ have low interest rates and massive monetary stimulus. The difference will be made in the fiscal space, where Japan is in the lead.
How will the USDJPY react next?