Asia Times | Bank of Japan turns into hedge fund

Investors are banking heavily on Japanese equities. Well, at least one: the country's central bank.

Foreign bettors apparently did not appear to sell yen-denominated shares quickly enough during the year ended March 31st. In fact, they slaughtered them by the largest margin in 31 years – $ 50 billion. This led the Bank of Japan to stock up on publicly traded funds – about the same amount.

The plot thickens with the fact that in 2018, the Bank of Japan's balance sheet exceeded the total size of Japan's GDP estimated at $ 4.9 trillion. First, Governor Haruhiko Kuroda's team grabbed the Japanese government bond market, hoarding more than half of the outstanding securities. Now it is the great value of the actions. Welcome to what is arguably the largest hedge fund in the world.

However, the BOJ's transactions are now officially one way. Six months ago, the Japanese gambled on the fact that the Bank of Japan would be "losing weight" or withdrawing from the most aggressive experience of monetary easing in history. The trade war of US President Donald Trump has turned this trade into a losing trade.

On the domestic front, Japan is not only struggling with a possible recession, but two elections are also coming. In April, voters will choose municipal leaders. In July, the deputies of the upper house will be on the ballot. The last thing Prime Minister Shinzo Abe needs is a growing slowdown that hinders the prospects of his Liberal Democratic Party.

The same goes for Kuroda who, after six years of work, does not reach his inflation target of 2%. This basically traps the BOJ. Reducing bond purchases and rising yields, further strengthening demand from businesses and consumers. Reduce the ETFs and craters of the Topix stock index. Even after $ 50 billion of largesse from the central bank, the Topix has lost nearly 4% in the last 12 months.

The lesson for central banks around the world is that it is one thing to place one's tentacles in a myriad of badet clbades. Get out a completely different. Kuroda has started every year since 2015 with the big project to end the annual purchases of 80 trillion yen bonds by the BOJ (716 billion USD) and to reduce the participations in other areas of the debt.

Ditto for having limited support for the stock market. There is something unpleasant about the fact that the central bank of a developed economy is the largest shareholder. China maybe. Member of the Group of Seven, Japan, not so much.

It is also worth noting why foreign bettors are retreating to Japan. Trump's trade war could be directed against China, but Abe's Japan is taking some of the biggest hits. Despite all the discussions on structural reforms, Abe has made little progress since 2012 to reduce Tokyo's exposure to exports.

Overseas shipments from Japan fell 1.2% from one year to the next in February, a third consecutive monthly decline. It should be noted that the January drop was a 8.4% loss for the stock market. The quarterly BOJ tankan Survey of major manufacturers dropped the most in six years in March. The barometer under close surveillance has not improved at all since the end of 2017.

It can be inferred that the stimulating effects of the 30% drop in the yen over the past six years are diminishing. Trade war destroys confidence on all fronts – among consumers, businesses and investors. The same goes for Tokyo's participation in bilateral trade talks with Trump's White House. Abe's team fears that these talks include Japan's request to accept a stronger exchange rate.

This will pit the BOJ against the Federal Reserve, which is under increasing attack by Trump's White House. In addition to saying the Fed is "crazy," Trump urges Governor Jerome Powell to cut short-term rates by 50 basis points. Any attempt by Kuroda to add stimulus measures to protect the economy will surely go against Trump, putting Japan even more at risk.

Can Japan withdraw from the markets? It will be years until we know for sure. If the Abe team had done more to reform labor markets, encourage innovation or cut red tape, the BOJ could chart a course against the nationalization of markets. Unless there are bold structural changes, the Kuroda Partners LP hedge fund will buy Japanese bonds and equities indefinitely.