Nikkei’s Resilience against BOJ’s Interference

The Bank of Japan (BOJ) may be hesitant to raise interest rates due to the Nikkei 225’s surge to 34-year highs, causing concerns about the potential dissuasion of normalizing monetary policy. The BOJ’s history of hitting monetary brakes during stock rallies, such as the December 1989 rate hike, has led to a deflationary nightmare. The increase in short-term rates to 4.25% seemed like a rational response to inflation pressures at the time, but it marked the beginning of Japan’s “bubble economy” era.

The BOJ’s tightening move marked the top tick of Japan’s “bubble economy” era and the start of a deflationary nightmare from which Japan is only now starting to recover. Today, economists know that Mieno’s BOJ’s decision to tighten the monetary brakes on December 25, 1989, destabilized everything above and below, setting Japan’s lost decades in motion. While the large rallies in real estate and stocks might have been better tamed with macroprudential policy tweaks by the Ministry of Finance and regulators, Tokyo’s politics were going through a unique period of volatility at the time.

In 1989, Japan had three different prime ministers, with asset bubble management duties left to the BOJ. After Mieno’s retirement in 1994, Yasuo Matsushita took over, but Japan fell into deflation by 1998. Governor Hayami was the first central bank leader to cut rates to zero in 1999, leading to the BOJ’s pioneering quantitative easing (QE). Fukui ended QE in 2003, but the Tokyo establishment blamed the BOJ for the recession. Shirakawa restored QE in 2008, and Kuroda introduced hyper-aggressive QE in 2013.

Kuroda’s BOJ cornered the government bond market and nearly nationalized the stock market, becoming the biggest investor. This led to a 30% drop in the yen, boosted exports, and record corporate profits. In 2013, the Nikkei surged 57%. Since then, ultra-loose BOJ policies and government efforts to strengthen corporate governance have led to the benchmark’s current highs, with the benchmark up 45% over the last 12 months.

The Bank of Japan (BOJ) has been cautious about stepping away from quantitative easing (QE) due to the market’s current bull run. In December 2022, Kuroda allowed 10-year yields to rise as high as 0.5%, leading to global markets quaking and the yen and Japanese yields skyrocketing. However, after December 20, 2022, Kuroda’s team made large bond purchases to cap yields.

In March, Ueda took control of the BOJ’s controls and tested the waters by letting 10-year rates rise to 1% and beyond. The Bank of Japan (BOJ) reassured bond traders that no significant policy changes were planned, and has not hinted at dismantling QE, abandoning negative yield policies, or implementing an official rate hike. As 2024 began, conventional wisdom suggested a rate hike by next month, but Japan’s recession has made this timing a moving target, with analysts stating the BOJ is not in a rush to hike rates.

Etsuro Honda, former special advisor to Japan’s Cabinet, opposes ending negative rates, stating that negative rates are used for inter-bank operations and apply risk premiums when it comes to corporations where no one is asking for borrowing with negative rates.

The Bank of Japan is expected to act as inflation remains above the target, confirming market expectations for a rate hike in the first half of the year. However, this view ignores the colliding effects of 1989 and 2024’s economic uncertainties. Japan’s crash in the early 1990s and the resulting bad loan crisis caused deflation and pushed the financial system to the brink. In 1997, Yamaichi Securities collapsed, causing markets to shake.

The near miss might also be factoring into Ueda’s calculus as he mulls withdrawing liquidity. Japan’s vast network of profit-starved regional banks has been reluctant to consolidate or fully embrace digitalization trends disrupting the globe. As the population ages and the corporate exodus to Tokyo accelerates, there’s less demand for loans from rural lenders.

Deflation trauma has led to more conservative mid-size lenders, with many regional banks buying government and corporate bonds, making balance sheets vulnerable to higher long-term rates, potentially pushing some rural lenders into insolvency.

The Nikkei stock market rally in Japan is still in its early stages, with foreign fund inflows still in its early stages. Analysts believe the market can surpass all-time highs and that the Nikkei boom will encourage corporate growth investment and capital efficiency. However, if the BOJ is perceived as the spoiler, the political empire in Tokyo might react.

The ruling Liberal Democratic Party’s unpopularity with voters is evident in the 17% approval rating of Prime Minister Fumio Kishida, who entered 2024 with a 17% approval rating. The LDP’s actions could push back on any signs of global market shock.

The Nikkei rally could potentially boost Kishida’s support numbers and create a “wealth effect” for businesses and households. However, the surge could also negatively impact the BOJ headquarters, as conventional wisdom about the BOJ in 2024 may be misguided.

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