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Japan to Raise Interest Rates - GoldChris Laird The EU is talking about another interest hike. China, the US, and about 22 nations in all are raising interest rates in tandem, or are pulling liquidity out of their banking systems. The big two are the US and Japan. The combined size of the USD universe and the Yen universe make up the vast majority of the money in the world. Hence their interest rate moves greatly affect the world economy, financial markets - and gold. This is a major sea change from the recent past. Japan flooded the world with cheap money right after their market crashes in the early 1990's. Their real estate and stock markets tanked then. Since then, the Yen carry trade has just exploded, and that money has found its way into every major financial market. The Yen carry trade is where investors borrow Yen very cheap, then invest that for a nice yield gain in US treasury bonds, for example. The net gain is about 3% over what it costs to borrow the Yen from Japan. The Yen carry trade also spills into all major financial markets as well, as investors borrow Yen cheap and speculate with the money. The BOJ and the EU central bank have stated publicly that they are concerned about the effect of raising interest rates on this Yen carry trade. If Japanese rates are raised, investors counting on the yield gain of the Yen carry trade will start liquidating those positions. The trouble is that the Yen carry trade has been allowed to go on for so long, that there are literally trillions of dollar value of borrowed Yen out. These borrowed Yen are going to eventually be liquidated back out of the markets they were invested in. The ultimate pace of that liquidation will depend on how fast Japan raises. I suspect that the gold market is going to find this Japanese move gold suppressive. First, the Japanese are gold friendly culturally. But if Japan raises rates, Japanese investors will find gold less attractive. The last time there was major news of changes in Japanese interest rates (the possibility of them rising) gold tanked about 30 bucks. That was when gold was under $500 last Fall. The other reason raising Japanese rates would suppress gold is that there could be general market liquidation from unwinding the Yen carry trade, and I suspect that some of this has found its way into the gold/precious metals markets. Hedge fund speculation would figure here. I have noticed that recently, financial markets are trending in tandem up and down with gold. This is somewhat unusual because normally gold and financial markets move inversely. Last week, when the Fed indicated it may consider pausing US interest rate hikes, the world stock markets rose quite a bit, and gold rose about 27$ on Friday. No doubt, a big part of why gold rose last Friday was the possibility that the US would pause hiking. Gold has found rising US interest rates quite suppressive. Normally, if the Fed raises, gold finds this suppressive. I would expect that, if Japan indeed raises interest rates next week, gold could drop as much as 30 to 50$. Remember, Japan and the US are the Big Two of easy money. Any tightening by either has a huge effect on precious metals. The main issue here is not the likely minute size of the interest hike from Japan as much as it is indicating a sea change for Japanese interest rates. The sea change is what will cause the gold reaction. IF Japan were to decidedly join the interest rate hikes across the world, then the last major economy that was not raising will now have changed direction. I expect the BOJ to use baby-baby steps. I am sure they are quite aware of the danger of unwinding the Yen carry trade too fast. The last time that happened, there was the '97 Asian financial crisis. Unexpected unwinding of the Yen carry trade amidst the market turmoil then caused financial panics and market liquidations across Asia. That episode is one reason China is so reticent to change their quasi USD link to the Yuan-RMB. That link was strengthened greatly in the aftermath of that crisis to protect the Yuan-RMB from further episodes of instability. Likely sizes of the first increase by Japan are 10 to 20 basis points. (.10 to .20 %). Another important issue is that the vast majority of the derivatives market is interest rate swaps. That segment is over 70% of the derivatives market which is over $400 trillion in size. Since practically the entire world is now raising interest rates in tandem, and now Japan is finally going to raise, I would definitely be on crash alert for markets due to both the imminent unwinding of the Yen carry trade and the pressure a rising world interest rate environment is putting on derivatives. Chris Laird The Prudent Squirrel Newsletter is a big picture gold and economic commentary. Stop by and have a look. 321gold Inc |
