Japan ends negative interest rates, will the Fed kneel under Mrs. Watanabe’s skirt?

Source: Liu Jiaolian

Death under the peony flowers, even being a ghost is romantic.

The crypto market and U.S. stocks have once again diverged. Driven by the sharp correction of BTC, the entire market suddenly became negative. On the U.S. stock market, the scenery is unique. The S&P 500 has climbed to its historical peak of 5,180 points, rising 26% from its local low of 4,100 points at the end of October. Unemployment fell and wages rose. This spectacular scene has actually attracted countless analysts to applaud and praise, saying that the U.S. economy has unexpectedly successfully achieved a "soft landing", and what will follow is an economic take-off and re-entering the fast lane of rapid development. Life is getting better and better.

The Bank of Japan (DOJ, also known as the "Bank of Japan") knows when to take action. Although the rating agency Moody's commented that it was "acting in haste", the Bank of Japan still officially decided on the 19th to end the eight-year negative interest rate policy and begin to seek a path to normalize interest rates.

History, every time the Japanese yen raises interest rates, it will be the last straw that breaks the United States' refusal to decline. Could it be that this time is another "this time is different"?

Mrs Watanabe (referring to Japan’s unique and large group of full-time housewives) manage their finances at home. They often take advantage of the Bank of Japan’s low interest rates and lend almost free Japanese yen. With the opening of Japan’s foreign exchange , converted into U.S. dollars to scoop up the Federal Reserve’s high interest rates. According to research, the liquidity held by wives is as high as trillions of yen, which is almost comparable to conventional liquidity in the foreign exchange market.

It should be noted that the Federal Reserve's wool not only has high interest, but also is risk-free interest. Suitable for risk-averse Watanabe wives. Wives went out in force, throwing yen and buying dollars. The yen fell and the dollar rose.

Maybe you are wondering, just by allowing wives to "escape" by exchanging currency, why didn't Japan's foreign exchange collapse?

Who are the younger brothers of the Federal Reserve whose currency is interchangeable? Bank of England, Bank of Canada, Bank of Japan, European Central Bank, Swiss National Bank. The Bank of Japan is clearly on the list.

So, no matter how many yen Mrs. Watanabe lends and sells them to the Bank of Japan, the Bank of Japan can take the newly added yen and find its big brother, the Federal Reserve, to exchange them for fresh U.S. dollars. The U.S. dollar and foreign exchange are “inexhaustible”.

Wonderful, really wonderful.

As a result, the Bank of Japan's negative interest rate policy and the Federal Reserve's high interest rate policy have created an excellent arbitrage space for Mrs. Watanabe. In essence, it is equivalent to the Federal Reserve giving water to Mrs. Watanabe, allowing them to take these fresh dollars and deposit them back to the Federal Reserve to eat the interest rate difference.

Dear readers, do you really think that the so-called Mrs. Watanabe is really just a lady wearing an apron?

The Japanese yen, which has long implemented low or even negative interest rate policies and yield curve control (YCC), has become an extremely rare "feng shui treasure" in the world. Since it is possible to borrow money for free, which international capital aiming to maximize profits would not want to use this free leverage to amplify its own investment returns?

So, when the Japanese yen raises interest rates, it will affect the whole body. A small perturbation to the leverage pivot cost may cause dramatic fluctuations in the price of the leveraged tail asset.

When the cost of leverage increases, urging Mrs. Watanabe to sell U.S. dollar assets and exchange U.S. dollars for Japanese yen to repay debts, it will cause significant fluctuations in the price of U.S. dollar assets and a relative appreciation of the Japanese yen against the U.S. dollar. .

The Fed appears to have been shrinking its balance sheet over the past two years. But it has been releasing water in a directional way through arbitrage structures like Mrs. Watanabe. So we will see that throughout 2023, the more the Fed raises interest rates and shrinks its balance sheet, the more bullish U.S. stocks, gold, and Bitcoin will be.

Now that the Bank of Japan has raised interest rates, this has thrown a difficult question to the Federal Reserve: Should it continue to maintain high interest rates or even raise them even higher, maintain the same arbitrage space, and retain Mrs. Watanabe; or should it take advantage of the trend to borrow money? The donkey is under the slope, the interest rate is cut and the water is released, filling the hole left by the Watanabe ladies after their withdrawal, and supporting asset prices?

The timing at this moment is quite delicate, because these two days coincide with the Federal Reserve’s interest rate meeting in March.

Although, the economic data in the past half month, especially the rebound in inflation data, has not only completely canceled the market's expectations for an interest rate cut in March, but has even significantly reduced the probability of an interest rate cut in June.

However, as Nick Timiraos, known as the Fed’s mouthpiece, pointed out, “At this week’s meeting, the debate among Fed officials is likely to focus on how to start cutting interest rates in the middle of the year.”

The implication is that an interest rate cut is no longer a question of whether it should be done, but a question of how to find a reasonable reason for the need to cut interest rates.

So, what is the situation that forces the Federal Reserve to actively seek ways to cut interest rates when inflation control is clearly not on track to achieve its goal?