Tokyo Market Rout — Oops, the BOJ Did It Again

The Sahm Rule might be a good indicator of a recession. But the timing of when the Bank of Japan unnecessarily hikes interest rates might be even better. 

Until the events of recent days, Bank of Japan Governor Kazuo Ueda had earned plaudits for unwinding the massive stimulus policies of his predecessor without spooking the markets. That praise now looks premature. In stark contrast to March, when the Nikkei 225 Stock Average tested new all-time highs as Ueda eased the country out of negative interest rates, his second hike July 31 has been followed by a market bloodbath of almost unprecedented levels. 

The rout extends far beyond Tokyo, and as my colleague John Authers has written, has more to do with what’s happening on Wall Street and expectations for the US economy than anything specific to Japan. By late Monday in Asia, markets in Taiwan and South Korea had similarly bled, and the Nasdaq was set to follow.

But Japan is the only place to have just raised rates in a historic decision that was already controversial even before the rout. And it saw some of the most outsized moves, with the superlatives hard to overstate. The Topix and Nikkei 225 both closed down more than 12%, the most since Black Monday in 1987. The three-day decline in the Topix is the worst ever. Futures in the indexes were halted for the first time since the Fukushima Dai-ichi nuclear plant was melting down in 2011, when it seemed the country might be on the brink of collapse. An index of banks saw the biggest one-day plunge in history. The 10-year JGB yield slid the most in 20 years, while the yen rallied to levels not seen since the start of the year. 

Authorities could hardly have been expected to see this coming. The BOJ’s move coming just before the markets, already jittery by the Fed’s delay in cutting rates, got spooked by a bad jobs data print is unfortunate. But it doesn’t point toward incompetence, especially with senior politicians having heaped pressure on the bank by calling for a rate hike. 

Nonetheless, if the market expectations of a US recession turn out to be true, the BOJ’s move will prove to once again have been spectacularly poorly timed. The Sahm Rule, which as discussed here by creator and Bloomberg Opinion colleague Claudia Sahm, uses the unemployment rate to detect the start of an downturn. We should consider a BOJ Hike Rule. The bank’s history of hiking is a consistent one of making the wrong move implemented at precisely the wrong time as the global economy heads into recession.

That’s what happened in 2000, when the government sought to delay the bank from prematurely abandoning its zero-rate policy — something that Ueda, then a board member, wisely opposed. Both were shot down. Just months later, the policy was back and quantitative easing introduced as the dot-com bubble burst. Hikes in 2006 and 2007 lasted little longer, until the collapse of Lehman Brothers. 

In neither case was the BOJ responsible for what happened. But even at the time, there was ample criticism that the moves were premature and unnecessary for an economy that needed the most accommodative policy possible. 

While it’s too early to assume that this rout will have cancelled Ueda’s plans to raise rates further, it will certainly give him pause — and send chills through politicians, many of whom will be reversing their hawkish stance as the ruling party leadership election nears .

It also raises questions over why Ueda saw the need to act now, having moved so slowly and methodically during his first year in office. It’s hard not to wonder if political pressure to do something about the continually weakening yen may have been coming to bear; otherwise, such a step seems unwarranted. 

Japan needs to carefully manage consumer and business sentiment for a population unused to dealing with these conditions. The “virtuous cycle” of wage and price increases is fragile, assuming it exists at all. Headlines about the market rout, in a year where the government has been aggressively pushing investment in expanded tax-free accounts, risk denting consumer appetite. Yet on Monday, authorities were largely AWOL. 

This Black Monday felt like sheer panic rather than logical reaction, but then markets frequently aren’t rational. Ueda will need to be when considering his next step. 

From Bloomberg Opinion: 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Gearoid Reidy is a Bloomberg Opinion columnist covering Japan and the Koreas. He previously led the breaking news team in North Asia, and was the Tokyo deputy bureau chief.

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