Markets must keep watching Japan as there are big risks brewing

The country’s central bank is engaged in a titanic struggle with bond and currency markets

The Magnificent Seven may be one of the most famous films, or at least most famous Westerns, ever made, but both the 1960 version (Yul Brynner, Steve McQueen and the rest) and the 2016 remake (with Denzel Washington and Chris Pratt, to name but two) draw heavily on 1954’s Seven Samurai and the work of legendary Japanese film director Akira Kurosawa.

But it is not just in the world of cinema where the West can take inspiration, and learn, from Japan. What is happening in Japan’s financial markets right now could have implications for investors, not to mention central bankers and monetary policy, in London, Washington, Frankfurt and elsewhere, because the Bank of Japan (BoJ) is still locked in a titanic struggle with the Tokyo’s bond and currency markets.

To Infinity And Beyond

Unlike the US Federal Reserve, the European Central Bank and the Bank of England, the Bank of Japan is yet to raise interest rates and it is yet to officially try to sterilise quantitative easing and launch quantitative tightening, whereby its balance sheet starts to shrink.

The BoJ’s zero-interest-rate policy dates back to 1999 and quantitative easing to 2001. Those dates should be a clue as to how hard Western central banks might find it to move away from them on a sustained basis, even if stock and bond markets right now appear to be pricing in a golden trifecta of a slowdown in inflation, a peak in interest rates and a soft landing for the global economy.

That would be nirvana indeed. But the BoJ has consistently found it hard, if not impossible, to tighten monetary policy for long and in 2016 it even launched QQE – quantitative and qualitative easing – so it could bring in yield curve control. Under the latter, the BoJ stated it would buy unlimited amounts of Japanese government bonds – and in effect print unlimited amounts of money – to hold the yield on the benchmark 10-year bond below 0.25%.

After six years of that, even Japan began to see some inflation, and the sort of inflation for which