by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] The big news overnight came from Japan as PM Abe’s cabinet approved the ¥28 trillion stimulus package.  Actual new spending is only about a quarter of the headline number.  The JPY appreciated on the news and the JGB saw a modest uptick in yields.  Overall, the package disappointed investors.  Some of this disappointment is being attributed to the lack of new bond issuance and the decision not to issue 50-year JGB.  It should be noted that the BOJ held an “emergency” meeting today.  All that emerged from the meeting was Governor Kuroda’s promise that the upcoming stimulus report “would not disappoint.”

However, it appears to us that all the packages (this is reportedly the 28^th fiscal stimulus package since 1990) will fail without one critical element—Japan needs a weaker JPY.  So far, Japanese policymakers are allowing themselves to be boxed in by the G-7’s promise not to use competitive devaluations to support economic growth.  We suspect that, at some point, these promises will be jettisoned and open currency warfare will emerge.  Eisuke Sakakibara, the former finance minister who engineered the weaker JPY and the Halifax Accord in the mid-1990s, said today that he believes the government’s trigger point would be a 90 ¥/$ rate.

How would Japan force the JPY lower?  Think of Japan conducting QE by purchasing U.S. Treasuries.  There would be much howling by other nations but the bottom line is that foreigners don’t vote in other countries’ elections.  Competitive devaluations and subsequent retaliations were the bane of the 1930s; the rise in populism increases the likelihood of a return to such policies.

The Reserve Bank of Australia cut its main lending rate to 1.50%, a 25 bps cut, the lowest policy rate on record.  The move was generally expected by the financial markets but the fact that the rates have hit a new record low is newsworthy.  Interestingly enough, the AUD rallied on the news.  This may have occurred, in part, because the RBA didn’t signal further easing.  However, the biggest factor in exchange rates right now is probably U.S. monetary policy.  If the money markets have this right, and the FOMC stays on hold, the dollar will probably weaken in the coming months.

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