For over a decade, the Bank of Japan has been pouring torrents of money into its economy; and for over a decade, much of that money has been spilling over into U.S. markets.
But exactly one week from now, on July 14th, we could see the first step toward a major change in that trend.
That’s when the Bank of Japan will likely raise short-term rates for the first time in almost six years.
That’s when Japan’s fire hose of free money could start sputtering.
And it’s also when you could see a tsunami of selling in high-risk U.S. assets and bonds — driving interest rates even higher on our side of the Pacific.
My recommendation: Do not underestimate the significance of this event.
Why Japan’s Rate Hike Is So
Important to U.S. Investors
Many U.S. investors focus solely on the Federal Reserve Board. They think our central bank is the only one that matters. When investors saw the Fed chicken out last week — failing to signal an aggressive inflation-fighting stance — they snapped up both U.S. stocks and bonds.
However, the fact is that global interest rate markets are interconnected like never before. What central bankers do overseas is as important, if not more important, than what our Fed does here.
Why? Because money flows from country to country much more easily today than ever before.
You, your neighbor — even your stockbroker — might not give a hoot about what’s going on in Japan’s economy, or what its central bank is doing.
But the bond managers who trade hundreds of millions of dollars worth of Treasuries sure do. So if you want to really know what’s driving interest rates, you’d better pay attention to what’s going on in Japan.
Sure, the U.S. capital markets are the biggest in the world. But the U.S. markets are international. Foreign money managers invest billions of their dollars in our bonds and stocks.
Indeed, foreign investors now own more than half of our publicly held Treasuries.
Result: Our markets depend on foreign money. If the flow of money from abroad — especially from Japan — slows down or reverses, then U.S. bonds and high-risk assets are likely to sink.
And that’s exactly what could start happening one week from today when the Bank of Japan raises its interest rates for the first time in six years.
We’re talking about a monumental policy change in Japan. Here’s why it’s happening …
Japan Is The World’s Second Largest Economy!
And Now It’s Swinging from Deflation to Inflation.
Japan is the world’s second largest economy, surpassed only by the United States itself. For the longest time, however, it was struggling to get its head above water. Reason: Massive bubbles in stocks and real estate popped in the early 1990s.
The Bank of Japan (BOJ) tried desperately to revive retail sales, employment, and corporate spending by cutting interest rates. Rates fell and fell. All the way down to a big fat ZERO!
Then something very unusual happened in 1994: Inflation (rising prices) flipped into deflation (falling prices). And despite some minor bounces, prices continued falling month after month, year after year.
So, except for one brief hike, the BOJ kept rates at rock-bottom levels.
Official short-term rates have been glued to the zero line ever since.
And the BOJ even went beyond just zero-percent interest rates. It flooded its economy with money in a desperate attempt to end the deflation.
In the U.S., if our Fed did something like that — handing out free money to banks like Citigroup or Bank of America, you’d expect those banks to lend it out to consumers and businesses, right?
Well, that’s not what happened in Japan because nobody wanted to borrow:
- Consumers weren’t taking out home mortgages because real estate prices were falling.
- Manufacturers weren’t borrowing to build factories because there were too many old ones sitting unused.
- Retailers didn’t want to borrow because deflation was driving down the price of their products. They certainly weren’t interested in opening up new stores.
So where did all the Japanese money go? It didn’t just sit in Japanese banks.
The Torrent of Cheap Japanese
Money Flooded into the U.S.
Markets and Other High-Risk
Assets Around the World!
Japanese banks, insurers and other investors poured money into U.S. bonds and other assets.
International hedge funds and other global investors did the same. They realized money was “on sale†in Japan. So they borrowed cash from Japanese banks at virtually zero cost, and plowed that money into U.S. investments with higher yields.
They poured the Japanese money into U.S. subprime mortgage bonds … U.S. junk bonds … U.S. commercial real estate … U.S. Treasuries — anything that yielded significantly more than 0%!
Heck. It cost virtually nothing to borrow the cash from Japan. So “why not?†was the attitude.
There’s a fancy Wall Street term for all this — the “yen carry trade.†“Yen†because they were borrowing in yen. “Carry†because their carrying cost (interest) was extremely low. And “trade†because they were using the cheap money to buy all kinds of other higher-yielding assets.
All this was great for U.S. markets while it lasted. But now it looks like the party may soon be over.
Reason: Japan now needs the money back — for its own growth. Indeed …
Japan Is Now on Track
For Its Biggest Growth
Since World War II
Starting in 2003, a strange thing happened: Japan began waking up!
The boom in China (a key Japanese trading partner) … the U.S. recovery … and the synchronized, inflationary monetary policies pursued by central banks all over the world … helped Japan finally emerge from its economic torpor.
Just this week, we got a peak at Japan’s hugely important “Tankan†survey of corporate confidence, and investment and spending plans. It showed that Japanese companies plan to boost spending by 11.6% — the most in 16 years.
Meanwhile, inflation is back!
Prices are now finally rising on a consistent basis. In fact, Japan’s “core†inflation spiked 0.6% year over year in the most recent month. It may not sound like a lot to you, but it’s their biggest rise in eight years!
The impact in Japan:
- Yields on longer-term Japanese bonds are heading up.
- Excess bank reserves are being drained off by the BOJ — about 15 trillion yen in the past couple of months.
- And here’s the clincher: At the end of the BOJ’s two-day policy meeting on July 13 and 14, interest rates are probably going to be hiked for the first time in six years.
Result: Japanese money flows into the United States are likely to slow down, and perhaps even reverse. The first victims:
- High-yielding U.S. mortgage bonds, corporate bonds and municipal bonds.
- Long-term U.S. Treasury bonds.
- Interest-rate sensitive stocks — building companies, mortgage banks, and others.
- Residential and commercial real estate.
Virtually every market that has benefited from the influx of Japanese money over the years could take some severe hits.
So keep your eyes trained on Japan: A tsunami of interest rate turmoil could be headed our way.
Until next time,
Mike
For more information and archived issues, visit http://legacy.weissinc.com
About MONEY AND MARKETS
MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Colleen Collins, Amber Dakar, Ekaterina Evseeva, Monica Lewman-Garcia, Wendy Montes de Oca, Jennifer Moran, Red Morgan, and Julie Trudeau.
Attention editors and publishers! Money and Markets issues can be republished. Republished issues MUST include attribution of the author(s) and the following short blurb: This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://legacy.weissinc.com
© 2006 by Weiss Research, Inc. All rights reserved.
15430 Endeavour Drive, Jupiter, FL 33478
