The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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February 21, 2007

A Dent In The Yen Carry Trade... Oh, Wait

A few weeks back, my friend Edward Hugh was monitoring the then latest thinking from the Bank of Japan:

Bank of Japan policy board member Hidehiko Haru has underlined what most Bonobo readers should already know, that internal consumption in Japan is week and that there's no threat that rising prices will cripple economic growth. Conclusion: there's no hurry to raise rates:

"Given that there's no evidence of any inflationary risk, there's no need to rush,'' Haru, 69, said today in a speech to business executives in Shizuoka city, Japan. "Gradual adjustments will be needed and will be made based on improvements in the economy and prices.''

Apparently, the "gradual adjustments" phase has arrived.  From the Financial Times:

The Bank of Japan’s policy board on Wednesday voted eight to one to raise interest rates a notch to 0.5 per cent, pointing to strong economic growth data as it made the first increase since July...

The BoJ’s decision to raise rates came as the result of strong growth in the fourth quarter, when gross domestic product expanded by 4.8 per cent on an annualised basis. That was the only significant positive piece of data released since last month when the board voted six to three against a rate increase.

Why?  Good question, I guess:

Masaaki Kanno, chief economist at JP Morgan in Tokyo, said: “It is a little puzzling to explain why five board members changed their mind.” He said the GDP data on its own, by definition backward looking, was not enough to explain a rise in terms of the bank’s stated forward-looking framework...

However, leaving aside what he said was the bank’s failure properly to explain its rationale, Mr Kanno said the board was justified in raising rates. He said it had stressed the second pillar of its policy framework, which concentrates on risks. These included the possibility of an asset price bubble and, particularly, risks associated with the weak yen, he said.

Yuka Hayashi, reporting for The Wall Street Journal, expands on that idea:

"As world financial markets become integrated, the time has come for us central bankers to conduct monetary policy while keeping firmly in mind its external consequences," BOJ Governor Toshihiko Fukui told a news conference.

Specifically, the governor said the BOJ wanted to quench expectations that Japanese rates would stay very low for very long, which might cause them to take "extreme positions." He said the BOJ had in mind, among other aspects of global markets, the so-called "carry trade," where investors borrow money at Japan's low rates and invest it elsewhere where returns are higher. Mr. Fukui said such borrowing could present a risk to the global economy if unwound suddenly.

But, my oh my, how events have a way interfering with the message.  From Bloomberg

The dollar approached a four-year high against the yen and rose versus the euro after a government report showed U.S. consumer prices in January increased more than economists forecast.

Investors bought the U.S. currency as signs of inflation may cut speculation that the Federal Reserve's next move is to reduce borrowing costs. The dollar's advance started after the Bank of Japan said further interest-rate increases would be gradual. The yen declined to near an all-time low versus the euro.

"The report works in favor of the dollar,'' said Shaun Osborne, chief currency strategist at TD Securities Inc. in Toronto. "Inflation is creeping up. The Fed is going to keep rates on hold. There isn't a rate decrease anytime soon.''

The more things change...

UPDATE: Brad Setser, insightful as ever, has some thoughts on the size of the carry trade, and adds that "the market consensus certainly seems to be that Japanese rates aren't going to rise far or fast enough to put a real dent in the carry trade."

February 21, 2007 in Asia , Data Releases , Exchange Rates and the Dollar , Federal Reserve and Monetary Policy , Inflation | Permalink


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Dave, (OT) If you haven't seen it, this Charles Hugh Smith post of 2/21/07 on our housing exposure presents a wealth of info. & includes a few wonderful links which were new to me.

Posted by: bailey | February 22, 2007 at 02:11 PM

the boj has lost a lot of credibility (if not all....).

on the one hand they want to stop the addiction of cheap money, they want to end the carry trade, they want to implement a forward looking policy, and they have adopted the "core" rate excluding food.....(they are really serious about their inflation fighting mission....) etc.......

The bank is counting on consumption, which accounts for 55% of Japanese GDP, to become the locomotive of the economy. Households are certainly spending what they have. According to the OECD, Japan's household saving rate has fallen by over eight percentage points since 1998, a deeper plunge than America's. The country's households now fail to dispose of just 2.9% of their disposable income.........(wow!!)


Posted by: jmf | February 23, 2007 at 03:30 PM

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