Previously, I was doubtful that yen would depreciate much further in 2016 and that BOJ is likely to tighten than to ease monetary policy. Of course, I was proven wrong after BOJ introduced negative interest rates on top of its current monetary base-targeting policy in January.
However, due to the decision made at a period of risk-aversion, including concerns about the solvency of Eurozone banks, we saw much positioning in long USDJPY squeezed out and a subsequent decline to 110.65. This reminded me of the importance of positioning and technicals that can cause a trade to go sour very quickly even if fundamentals were suggesting otherwise.
I do not expect a global recession (not the highlight of this piece) and therefore expect the yen to depreciate on the back of the declining volatility and USD strength. In the following sections, I will focus on the important factors that will shape the direction of the yen in the coming months.
In short, I think the current level presents a good opportunity to long USDJPY, given the proximity to corporate breakevens which I believe may force BOJ’s hand to intervene and unfavourable shunto developments. We also just ended a period of repatriation of Japanese corporates’ profits. Finally, if BOJ officials conclude that the economy can function relatively well under the NIRP, I believe it will provide more ammunition for further easing.
Fear of intervention will provide good support
In the recent annual survey released by the Cabinet Office on 26 February, the average breakeven USDJPY level for corporates was 103.2. This means that the BOJ has some buffer to go before an urgent need for intervention sets in. Traditionally, they have reacted by verbal intervention, followed by a ‘rate check’ (calls to brokers/banks to check their offer levels), before selling outright in the FX markets. In fact, we have already seen public comments by some officials, mostly notably by Governor Kuroda (‘a little excessive’) and Finance Minister Taro Aso, who said the yen’s rise was ‘rough’ and he will be ‘nervously watching these moves and will take appropriate steps as necessary’.
Repatriation month is coming to an end
March tends to be the seasonal month for Japanese corporates to repatriate their profits before the fiscal year-end, providing strength to the yen. In fact, data from BoP showed that 16% of total fiscal year repatriation in 2014 occurred in March. As we head towards the start of the new fiscal year, the pressure may fade and we may see renewed weakness in the yen.
‘Shunto’ wage negotiations have disappointed
The Japanese Trade Union Confederation (JTUC) recently released the preliminary results of its ‘shunto’ survey. The 0.47% base pay increase proved disappointing compared to the 0.80% rise in 2015. Given that its final increase for base pay increase in 2015 was 0.69%, the final result may not be too far off from the first-round result. Despite a marked increase in government pressure to raise wages, corporations have been resistant due to (1) lower inflation, which is a key negotiating chip for JTUC, (2) increasing uncertainties over the global economic outlook and (3) strengthening yen. All three factors contributed to a negative outlook surrounding future business conditions.
Another delay for tax hike?
Given that the April 2014 tax hike was largely blamed for pushing Japan in and out of technical recessions, there is a growing voice about another postponement of tax hike scheduled in April 2017. Public comments, most notably from Nobel laureate economists Joseph Stiglitz and Paul Krugman, continue to join the chorus of voices urging PM Shinzo Abe against raising tax from the current 8% to 10%.
Chief Cabinet Secretary Yoshihide Suga last week reiterated the government’s will to proceed with the tax bill unless ‘a major financial crisis or natural disaster struck’. If first quarter GDP data, due in May, surprised on the downside, it could well be a convenient excuse for PM Abe to postpone the tax hike.
Potential double election
If the tax hike is indeed due for postponement, it could give PM Abe incentive to hold the lower house election together with the upper house election in July to consolidate his political power. The risk would be that PM Abe would need to retain its two-thirds majority both the lower and upper houses in order to initiate the process for any constitution amendment. If successful, PM Abe could use the fresh mandate to take economic policy in a new direction, especially structural reforms such as labor market reforms and corporate tax cuts.
Divided but not deterred
At 5-4 vote, BOJ’s board has become the most divided amongst all other central banks, but the politics is favored towards Kuroda as two of the four dissenters Ms. Sayuri Shirai and Mr. Koji Ishida are slated to retire this year (March and June respectively) and PM Abe is likely to appoint dovish board members to give Kuroda a freer hand.
Negative interest rates across the world
Whether the BOJ will cut rates further into negative territory depends largely on the economic impact of negative rates on Japan’s economy. I therefore would take a quick snapshot of Sweden, Denmark and Switzerland to draw on their experiences. Currently, the rates are -0.75% in Switzerland, -0.65% in Denmark and -0.5% in Sweden. While they have very different objectives to start with (and have met with varying degrees of success), there has not been any significant adverse impacts on their wider economies.
The Swiss and Danish central banks were aiming to defend the appreciative pressure on their currencies as a result of ECB’s QE program, while the Riksbank was focusing on inducing inflation on the back of an economic expansion. According to a report published by Moody’s, the experience in Denmark and Switzerland was generally successful, but risks of an asset bubble in mortgage lending and house prices have started to raise concerns in Sweden. Yet, no systemic risks or banking crises have been flagged.
What form of easing will BOJ undertake?
If we assume BOJ’s assessment of NIRP benefits outweigh the costs, then further cuts would be an easy choice. Expanding JGB purchases at this point may cause confusion amongst market participants, and give them a reason to presume that BOJ has concluded that NIRP is not effective. Moreover, as I shared before, further expansion looks unlikely given liquidity constraints and the already large scale of purchases. In fact, the board probably pushed for negative rates because it is potentially a more sustainable rate of easing, as compared to monetary-base targeting alone.
Barring any significant downside pressures on the banking sector and the wider economy, I expect BoJ to go further into negative territory to -0.3% in July. However, given the considerable timeframe and the other uncertainty associated with tax hike, elections, shunto developments etc., the tail risk to my baseline expectations will be considerably large.
Best,
P
PERRYNOMICS 