*Written by Marcus Holland from Options-Trading.com
The decision comes with all kinds of risks, but Bank of Japan Leader Haruhiko Kuroda’s goal was to achieve a rate of inflation at 2 percent for Japan’s sluggish economy. The country has experienced a stagnant economy and falling prices in the last two decades. Falling prices hurt the country because companies are less likely to invest and citizens don’t want to spend money. Moreover, Japan has seen its export sector decline.
Given the government’s pressure to act, the BOJ, under Kuroda plans to spur purchases of bonds that will mature in seven years instead of the former goal of three years. The bank will up its purchase of bonds by 50 trillion yen, the equivalent of nearly 10 percent of the country’s annual gross domestic product. Breaking that down, the bank will purchase long term Japanese bonds per month, which is 70 percent of the country’s bonds that are sold in markets. The bank wants investors to buy riskier assets like property and stocks by pushing the bond yields down. It also wants companies and households to buy riskier assets now, instead of the future.
Bank of Japan’s Surprise Economic Solution
The stimulus plan targets the monetary base instead of interest rates, something the bank has abandoned. A similar policy was practiced in Japan from 2001 to 2006 with little effect. Kuroda said the new package will not spark a rise in long term interest rates or create an asset price bubble. The result of Kuroda’s decision, which was supported by the bank’s board of directors, had an almost immediate impact that was favourable to markets. The bond futures soared. The benchmark for 10-year bonds yielded 0.425 percent, the lowest ever, and the yen fell, which caused the U.S. dollar to rise more than 2 percent.
A chief economist at Tokyo’s RBS Securities said Kuroda is boosting monetary easing in volume and assets the bank purchases. Critics aren’t so kind. They say the move will place Japan more in the red. The country is already suffering the largest debt of all industrialized nations. While the markets reacted positively to Kuroda’s decision, the stimulus will not convince citizens and companies to borrow more money, critics say. They believe the money will stay with the banks and out of the real economy.
Critics also point out that massive bond sales will add to the government’s debt, and interest rates will rise because the rates will have to keep up with inflation. As a result, interest payments will also rise.
Forex and Contract for Difference (CFD)
In light of Japan’s bold stimulus package, Forex trading may become even common if the yen is carefully observed under Forex standards. Forex, or foreign exchange trading, is buying one currency with another for the present exchange rate, and watching the first currency to increase in value against the second currency. The first currency is then sold for a greater amount.
In addition, CFDs, or Contracts for Difference, target the underlying market and hedge existing investment portfolios. The CFDs go short, rather than long, and are designed to trade currency, energy and the major indices. They are used for a wide range of financial instruments, and they are flexible.
An example of Forex and CFD is a purchase of the Euro and the USD at 1.2750-1.2751. The investor believes the Euro will rise. Using a trading platform, the investor purchases five contracts at 1.2751.
Each contract is equal to 100,000 of the Euro. At five contracts, the Euro is 500,000 at 1.2751. This equals USD637,550. If the Euro rises as expected to 1.2870-1.2871, the investor sells the five contracts on a trading platform at a bid price of 1.2870. This equals out to USD637,550. The investor profits on the difference, which is USD5,950.
In retrospect, the contracts are worth USD10 every pip movement. The pip movement in this scenario was 119 with five contracts. The math for the equation is 119x5xUSD10, which equals USD5,950.