China-Singapore Jingwei, June 29th: The market should be wary of the Japanese debt circuit breaker rather than the sharp fall of the yen
The author is the global chief economist of BOC Securities
The global crisis caused by the divergence of Japanese and US monetary policies, as well as the spread of the epidemic and the conflict between Russia and Ukraine Due to supply chain disruptions and soaring commodity prices, the yen-to-USD exchange rate has fallen below 130 to 1 since May 2022 (unless otherwise specified in this article, it refers to the bilateral exchange rate of a certain currency against the US dollar). to a 24-year low. This has raised concerns about competitive devaluation and a return to the Asian financial crisis. However, the author believes that the sharp fall of the yen is not a concern, but the risks implied by the circuit breaker of Japanese government bonds should be paid more attention to.
After the Asian crisis, the influence of the Japanese yen exchange rate weakened
On July 2, 1997, the fall of the Thai baht triggered the Southeast Asian currency crisis, which gradually evolved into the Asian financial crisis that swept emerging markets around the world. During this period, the depreciation of the Japanese yen added fuel to the fire, directly bringing down Asia's traditional strong currencies and exacerbating the competitive depreciation of Asian currencies. By August 11, 1998 (the low point of the Japanese yen exchange rate in this crisis), the Japanese yen had fallen by 22% compared with July 1, 1997, and the Singapore dollar and the New Taiwan dollar had fallen by 19% and 20% respectively (see Figure 1) . At that time, the Chinese government promised not to depreciate the RMB, preventing the contagion of the confidence crisis and promoting financial stability in Asia and the world.
Figure 1: The exchange rate of the US dollar against some Asian currencies from the beginning of 1997 to the end of 1998
During the crisis, the exchange rates of other Asian currencies mostly "rose and fell" with the Japanese yen. According to the daily major currency exchange rate data released by the Federal Reserve , the correlation analysis after taking the natural logarithm of the exchange rates of major Asian currencies from the beginning of 1997 to the end of 1998 shows that the RMB and the Japanese yen are basically unrelated. During the same period, the Indian rupee, Malaysian ringgit, Singapore dollar , Korean won, New Taiwan dollar, Thai baht and the Japanese yen all had a strong positive correlation, and they all had a strong negative correlation with the RMB (see Table 1).
Table 1: Correlation between the US dollar exchange rate against major Asian currencies and the Japanese yen and RMB exchange rates
However, after the crisis, the aforementioned correlation changed. Similar processing of the data from July 22, 2005 ("7.21" exchange reform ) to August 10, 2015 (the eve of the "8.11" exchange reform) shows that the RMB and the Japanese yen have a strong positive correlation. During the same period, ringgit , Singapore dollar, New Taiwan dollar, Thai baht and Japanese yen all had a strong positive correlation. However, compared with the Asian crisis, the positive correlation weakened, and the rupee, Korean won and Japanese yen even turned negative. ; In addition to the rupee, Korean won and the RMB which continue to have a strong negative correlation, the ringgit, Singapore dollar, New Taiwan dollar, Thai baht and the RMB have all turned to strong or highly positive correlations. This shows that after the Asian crisis, the co-movements between other Asian currencies and the Japanese yen and the renminbi have waxed and waned. Among them, the positive correlation between the Singapore dollar, the New Taiwan dollar, and the Thai baht and the renminbi is significantly higher than the correlation with the yen.
performed similar processing on the data from the beginning of 2018 to the end of 2020 (since the RMB exchange rate returned to two-way fluctuations) and showed that the RMB and the Japanese yen are weakly negatively correlated. During the same period, the ringgit, Singapore dollar, Korean won, New Taiwan dollar, Thai baht and Japanese yen were all positively correlated. Except for the Thai baht, which had a strong positive correlation with the Japanese yen, other currencies had extremely weak positive correlations with the Japanese yen. The rupee and the Japanese yen are even negatively correlated; the rupee, ringgit, Singapore dollar, Korean won, and Taiwan dollar are positively correlated with the renminbi. Except for the rupee, other currencies have a strong positive correlation with the renminbi, and the Thai baht and the renminbi are weakly negatively correlated. Related. This shows that after experiencing the initial shock of the "8.11" exchange rate reform, the co-movement between Asian currencies and the yen has further weakened, and the co-movement with the RMB has strengthened.
further performed similar processing on the data from the beginning of 2022 to June 10, showing that the RMB and the Japanese yen are highly positively correlated. During the same period, the rupee, ringgit, Singapore dollar, Korean won, New Taiwan dollar, and Thai baht were highly positively correlated with the Japanese yen and the yuan. Among these six currencies, half of them have better correlations with the Japanese yen and the RMB. This at least shows that it is difficult to say that only the Japanese yen affects the exchange rate trends of other Asian currencies. Moreover, correlation is not necessarily causation.
The collective weakness of Asian currencies this year is more related to the Federal Reserve's unexpected tightening, which pushed the Intercontinental Exchange (ICE) U.S. Dollar Index to refresh a 20-year high.In the first five months, the Japanese yen's exchange rate against the U.S. dollar fell the most among the basket currencies of the U.S. dollar index, reaching 10.4%; the exchange rate of other Asian currencies against the U.S. dollar fell by 1.3% to 4.6%, which was higher than the 0.8% increase in the U.S. dollar index against emerging market currencies. , but lower than the decline of the yen (see Figure 2)
Figure 2: Changes in the U.S. dollar index and the U.S. dollar exchange rate against major currencies in the first five months of 2022 (unit: %)
The overall trend of the influence of the yen exchange rate after the Asian crisis weakened, benefiting from increased exchange rate flexibility in other Asian currencies. From 2005 to 2021 (since the "7.21" exchange reform), the average maximum annual exchange rate amplitude of the RMB, rupee, ringgit, Singapore dollar, Korean won, New Taiwan dollar, and Thai baht increased by 2.1, 1.6, and 3.2 respectively compared with 1992 to 1996. , 1.8, 10.5, 2.2, 8.1 percentage points (see Figure 3). This helps the exchange rate float to act as a "shock absorber" to absorb internal and external shocks.
Figure 3: The annual lowest amplitude of the exchange rate of major Asian currencies against the US dollar (unit: %)
Japan’s economic and financial influence in Asia is far less than before
In terms of economic size, before the Asian crisis from 1992 to 1996, Japan The global share averaged 16.8%, falling to 6.1% from 2016 to 2020, a decrease of 10.7 percentage points. During the same period, China's share rose from 2.1% to 15.9%, an increase of 13.8 percentage points. Most of the other Asian economies' shares also increased to varying degrees (see Figure 4).
Figure 4: The proportion of some Asian economies in global GDP and its changes (unit: %; percentage point)
Looking at international lending (including bonds and credit), among international claims, at the end of 1996, the Japanese yen accounted for 15.3%. It will drop to 5.4% by the end of 2021, a decrease of 10.0 percentage points; in international debt, the Japanese yen's share will drop from 10.1% to 2.6%, a decrease of 7.5 percentage points (see Figure 5). Although other Asian currencies are not yet able to challenge the yen's status in this regard, the yen's share has still declined significantly.
Figure 5: The Japanese yen’s proportion in international lending (unit: %)
For a long time, the Japanese yen has been the main financing currency for carry trades. Investors borrow low-interest Japanese yen to purchase high-interest assets in other currencies. Usually, interest rate cuts and depreciation of the yen are good for carry trades, while interest rate increases and appreciation of the yen are bad. An important background to the attack on the Thai baht in 1997 was that rumors of a Japanese yen interest rate hike triggered the unwinding of Japanese yen carry trades.
Looking at the global commodity export market share, Japan's share averaged 8.8% from 1992 to 1996, and dropped to 3.7% from 2017 to 2021, a decrease of 5.1 percentage points. During the same period, China's share increased from 2.6% to 13.7%, an increase of 11.1 percentage points. Most of the other Asian economies' shares also increased to varying degrees (see Figure 6). Japan's status in the global trade pattern has declined significantly, which has alleviated the pressure of competitive devaluation of Asian currencies triggered by the sharp fall of the yen.
Figure 6: Market shares of commodity exports of some Asian economies and their changes (unit: %; percentage points)
Looking at the composition of imported goods from the United States, from 1992 to 1996, Japan’s share averaged 15.0%, and from 2017 to 2021 It dropped to 5.4% year-on-year, a decrease of 11.6 percentage points. During the same period, China's share increased from 5.7% to 19.3%, an increase of 13.6 percentage points, while the share of other Asian economies increased or decreased (see Figure 7). It can be seen that even in the third-party market, Japan is not a major competitor of other Asian economies.
Figure 7: The proportion of Asian economies in U.S. imports of goods and its changes (unit: %; percentage point)
Obviously, following the experience of the Asian crisis, deducing the spillover effect of today’s yen exchange rate may be a "scratching boat to find a sword."
Pay close attention to the risk of the Japanese bond yield curve getting out of control
As the world returns to the era of high inflation, more and more central banks have started the process of monetary tightening. Especially because of the failure of the "temporary" and "peaking" theories of inflation, the Federal Reserve accelerated the pace of raising interest rates and shrinking its balance sheet. The June interest rate meeting raised interest rates by 75 basis points for the first time in 28 years.
Relatively speaking, although Japan's inflation has increased, it is generally mild. In addition, Japan is suffering from deflation and economic stagnation. Therefore, the Bank of Japan continues to implement government bond yield curve control (YCC, that is, the 10-year Japanese bond yield The policy of controlling the economic growth rate at about 0% and tolerating its fluctuation ±0.25%) supports economic recovery. This week's interest rate meeting reconfirmed this policy stance.
However, the market is betting that the sharp fall of the yen combined with the skyrocketing prices of commodities, especially energy and food, will increase imported inflation pressure in Japan and force the Bank of Japan to abandon the YCC policy. For this reason, investors have recently sold Japanese bonds aggressively. On June 15, Japan's 10-year government bond futures fell sharply during the session, recording the largest single-day decline in nine years and triggering the exchange's circuit breaker mechanism twice.
In order to calm the market selling pressure, the Bank of Japan increased its purchase of Japanese bonds. As of June 10, the balance of Japanese bonds held by the Bank of Japan increased by 6.64 trillion yen (see Figure 8); Japanese bonds accounted for 73.2% of the total assets of the Bank of Japan, an increase of 1.2 percentage points from the end of the previous year, and accounted for 73.2% of the total assets of the Bank of Japan this year. A new weekly high since. The sharp increase in the supply of Japanese yen in the market has further pushed down the Japanese yen exchange rate.
Figure 8: The Bank of Japan holds Japanese government bonds and the yield on 10-year Japanese government bonds (unit: 100 million yen; %)
If the Bank of Japan abandons YCC due to inflationary pressure, the yield on Japanese bonds will soar, which will cause the Bank of Japan to and other financial institutions suffered huge losses. In the first quarter of 2022, the Federal Reserve's holdings of U.S. debt and mortgage-backed securities caused a book loss of US$330 billion. According to estimates, if Japanese bond yields rise by 1%, the Bank of Japan's book losses will exceed US$220 billion.
The surge in Japanese bond yields will also threaten to increase the Japanese government's debt repayment burden. Low inflation and low interest rates are important prerequisites for the central bank to finance government deficits and implement modern monetary theory (MMT).
At the end of 2021, Japan's government debt burden ratio was 177%, an increase of 35.8 percentage points from the end of 2012, but the national debt service rate dropped from 24.3% to 22.3%. This is mainly because since 2013, the Bank of Japan has implemented a quantitative and qualitative easing monetary policy and introduced negative interest rates and YCC (see Figure 9).
Figure 9: Japan’s national debt burden and 10-year Japanese government bond yield (unit: %)
It can be predicted that if YCC breaks through, the Japanese bond yield will rise non-linearly. Every 1 percentage point increase in Japanese bond yields means that the Japanese government will use approximately 10% more of last year's fiscal revenue to pay interest on government bonds.
The resulting impact will far exceed the depreciation of the yen, and the impact will not be limited to Asia. For example, after the outbreak of the Asian financial crisis, the share of Japanese yen reserves in the world's disclosed currencies fell for a time, but began to rise again in 2015. From 2017 to 2021, the Japanese yen share averaged 5.51%, an increase of 1.68 percentage points from 2012 to 2016. percentage points (see Figure 10).
Figure 10: Major reserve currencies shares of the world’s disclosed currency composition (unit: %)
This reflects the efforts of the international community to diversify the allocation of foreign exchange reserve assets in recent years, but it also means that foreign official investors are more exposed Under the risk of fluctuations in Japanese bond yields. In addition, the Bank of Japan's abandonment of YCC may also intensify market tightening expectations, trigger the unwinding of Japanese yen carry trades, and trigger new global financial turmoil. By then, the yen exchange rate may rise instead of falling in the short term.
Coincidentally, the European Central Bank's new interest rate resolution also triggered concerns about the European debt crisis . On June 15, the European Central Bank held a special meeting to study and deal with this matter. The side effects of the Federal Reserve's violent interest rate hikes and the collective policy shift of major global central banks should not be underestimated. We may be witnessing history again. (China-Singapore Jingwei APP)
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