SPECIAL REPORT: Gold, Silver Scream Higher as Japan Acknowledges,Takes Steps to Fight Inflation
FIRST REPORT: Full Rundown
There are two ways to slow inflation: by hiking short-term interest rates or by forcing long-term interest rates higher.
Good Morning: The dollar is down 80 points. Bonds are weaker by about 10bps. Gold is up 1.5% at $1824. Silver is up over $1.00 at 24.21 ( 4.4%). Crypto is very strong. Oil is up 45 cents. Grains are all up and US stocks are up about 30 bps on average.
This is all reaction to the BOJ announcement.
Intro:
There will be alot of opinion pieces coming out on this. The purpose of this one is to help you get a handle on what happened, and from there you can make your own more informed opinion. It’s an area we feel comfortable writing on in a broad sense.
What follows is a hybrid of questions we asked ourselves, explanations we had to refresh on, and facts of the event
Our own opinion hasn’t changed ( anti-goldilocks), but will be titrated in terms of time frame by how the markets react. This isn’t about our opinion mostly. It’s about helping GoldFix members solidify theirs.
Good Luck
What Happened?
Japan surprisingly announced last night it was widening the interest rate band it permitted JGBonds to trade in from 0.25% at the extreme to top out now at 0.50%. Why?
As the BOJ had continued to enforce its prior 0.25% cap it was forced to spend ungodly amounts of reserves to do this. Synthetically through swaps, that bond was trading over 0.60% anyway. This made the BOJ the only buyer of this bond at 0.25%. Noone was investing in Japan’s long terms prospects.
At the bottom is the first report we were lucky enough to see describing how to trade this surprise event:
We’ll be reading this and others over the next 2 days for reporting
MORE AT BOTTOM…
Market Effect: The BOJ Raised its Dividend
Think of a currency as the stock of its country. The Bond yield is therefore the dividend on that “Stock”. The BOJ just now raised the dividend on its stock to attract investors. The following should happen.
The Yen strenghtens versus the dollar as the Yen’s higher interest rate attracts money.
The US 10 year Bond must weaken (its rates go up) too offset the outflow of money from its stock, the USD.
If it works, the whole world’s back-end yields rise, real rates become less negative, inflation gets quelled and the central banks have less need to raise short term rates
All of this Zoltan implied in a post entitled: Cure Inflation "By Forcing Long Term Rates Higher"- Zoltan Pozsar.
To the extent the markets differ from the above is a reflection of their (lack of) confidence in the plan.
Substantively they said:
We will permit the back end of our yield curve to float at a higher rate to reduce volatility while continuing to buy even more Bonds to enforce this change but not removal of cap.
What exactly did they say?
This is the important part of what was said:
At the Monetary Policy Meeting held today, the Policy Board of the Bank of Japan decided to modify the conduct of yield curve control in order to improve market functioning and encourage a smoother formation of the entire yield curve, while maintaining accommodative financial conditions.
And this:
While significantly increasing the amount of JGB purchases, the Bank will expand the range of 10-year JGB yield fluctuations from the target level: from between around plus and minus 0.25 percentage points to between around plus and minus 0.5 percentage points.
Full pdf of announcement at bottom…
They are also implicitly saying: Don’t call our bluff by jacking the other part of the curve higher again we do have the ammo to buy more bonds.
What are they Really Saying?
Our Interpretation:
We are worried about inflation, the ZIRP policy is no longer sustainable, and if we do not let backend yields rise, then this will get worse and we will spend too much of our economy just keeping the Yen from imploding as a trusted currency.
Two Ways To Lower Inflation
Since Volcker, the Fed has sought to actually keep long term rates lower by raising short term rates. In doing this they slow the velocity of money, make loaning money unprofitable and thus eventually reduce demand for dollars.
The second way to lower inflation, is “by forcing long-term interest rates higher”. The idea behind that is the more expensive it is to borrow, the less money will be borrowed. The spread between real rates and nominal rates at the long end must be closed.
GoldFix interpretation of Japan’s Point of View:
We must stop the weakening of our currency by giving people a higher interest rate to encourage yen ownership. In doing this we can get inflation under control, which will stop the yen from dropping, and in doing so rebalance our money with other fiat.
No doubt in very very close consultation with the US Fed
“Volatility” Means Inflation
When you read the word “volatility” in any bank statement surrounding this, replace it with inflation and the whole statement will make much more sense. For example:
Since early spring this year, volatility [INFLATION} in overseas financial and capital markets has increased and this has significantly affected these markets in Japan. The functioning of bond markets has deteriorated…
Another way to look at it is: when they say volatilty, they mean lack of faith in our policy.