The sudden strength of the Japanese yen isn't just a headache for Japan, it is an illustration that we may be reaching the limits of what monetary policy can accomplish.
The yen has rocketed higher against the dollar in recent weeks, touching 17-month highs and having gained 11 percent since the Bank of Japan introduced negative interest rates in January.
As the Abenomics plan to revive the economy is partly predicated on a weak currency spurring exports, this has not gone down well in Tokyo. Chief Cabinet Secretary Yoshihide Suga warned on Monday that the Group of 20 rich nations' agreement to eschew competitive currency devaluations was no bar to Japan intervening to stop "one-sided" moves.
With the International Monetary Fund holding meetings later this week, now would be an embarrassing time for Japan to sell yen on currency markets. But to view this as a short-term problem of financial diplomacy is to underestimate the depth of the problem.
"Already, there are important signs that the ECB and the BOJ are losing their influence on the markets," hedge fund manager Stephen Jen of SLJ Macro Partners wrote in a note to clients. "The latest correction in dollar-yen, for example, is a verdict that the BOJ's policies are no longer potent."
Negative interest rates in Japan have spawned negative unintended consequences. Stocks have fallen 13 percent, with banks, whose very business model is undermined, the hardest hit. That has left many with the belief that the Bank of Japan is constrained: neither negative rates nor its massive purchases of stocks and bonds are having the intended effect.
Many foreign investors, who had been enthusiastic supporters of the Abenomics experiment, have duly turned sour. Since just before negative rates began, foreigners have sold a net $46 billion in Japanese stocks. Many, including hedge funds, are unwinding trades in which they bought Japanese stocks while selling yen, which often moves in the opposite direction, as a safety measure. Sell the stocks, as many now are, and you also buy the yen.
Japan's problems are also partly made in Washington, where the Fed has turned less aggressive, sending U.S. interest rates lower and halving the real, or inflation-adjusted, difference between higher U.S. and lower Japanese bond yields. Buying Japanese bonds just isn't as unattractive as it was in January, ironically, and the market seems to doubt the BOJ's ability to make it a worse deal.
Acting Similarly, Not In Concert
Thus we have the Bank of Japan - and its government - painted into a corner.