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View: JPY response to ‘Risk on’ phase should worry BoJ, SNB style Peg worth debating
Despite solid gains in US and European markets over the past few months that Asia heavyweight Japan has enjoyed rather limited luck with even the BoJ’s efforts to continue on the central bank easing bandwagon given short shrift by the market. The performance of the JPY specifically must be worrying for Japanese officials, particularly its unresponsiveness to the ‘risk on’ mood which in the past has provided exporters with some much needed breathing space. Indeed, USD/JPY has been stuck sub 80.00 throughout Q3, in stark contrast to price action in Q1 where a similar ‘risk on’ phase was enough to push the pair up around eight big figures back towards 84.00. The implications if the mood shifts don’t look particularly encouraging with this in mind, particularly given the ineffectiveness of the BoJ’s preferred tools of verbal then physical intervention to contain unwarranted/undesirable JPY appreciation.
Full report below…
Liquidity pressures have forced the ECB to step into the market again, the bank announcing new six-month measures to try and ease money market tensions at this afternoon’s rate setting meeting (rates were held at 1.50%) in addition to the no doubt more distasteful step of returning to support peripheral bond markets – Portgual and Ireland benefitting in the first instance. Trichet claimed the bank had not previously ceased its purchase programme – stating he had never personally said it was dormant, but this just look like semantics to us. The bank has never been comfortable with this course of action and the fact that the ECB is back in the market (and not with unanimous support from the council) speaks volumes about the scale of the crisis enveloping the region and the steps needed to provide even a small perception of control.
The timing of today’s meeting is a little unfortunate given the moves from the Swiss National Bank, Bank of Japan and Central Bank of Turkey this week. While action during the first financial crisis was very much a global affair, what stands out now is the unilateral nature of these steps, The Turks noting the action was designed to protect against the risk from peripheral Europe and a US slowdown despite currently solid local macro fundamentals and already competitive exchange rate (earlier monetary policy moves having weighed heavily on the TRY). This is not that surprising, sovereign balance sheets have been trashed over the past three years, significantly weakening the hands of governments desperate to stimulate growth. Deleveraging, which was the only real solution, will never fit into the electoral cycle. The imbalances that contributed to the crisis are also still very much present, indeed in many instances exaggerated. One just has to look at Germany and the level of Asia FX reserves to see how the much criticised export driven model has survived.
There is a real risk now that these unilateral steps are repeated elsewhere as authorities look to build protection against the feared slowdown in global growth. Many indicators are already alluding to this, for example JP Morgan’s global PMI index (above) is now only marginally above the 50.0 level and Citi’s global economic surprises index (below) has been printing negative surprises ever since the Japanese earthquake, a sign the market is behind the curve. If one throws the probability of the odd sovereign default into the mix (peripheral Europe), the probability of a US downgrade and prospects for further tightening in China the temptation to try and get that first mover advantage can only increase.
It’s difficult to envisage a scenario where there is a clean resolution to current problems. If the Fed embarks on new policy stimulus it will likely be dollar negative, exaggerating tensions between the free floaters and the pegged currencies. Hopes of faster Chinese appreciation which might allow more flexibility across Asia doesn’t fit well with slowing global growth either. A round of competitive devaluations and a plethora of new tensions (i.e more obvious protectionism) looks like a logical next step, a multilateral solution will be near impossible to forge if this begins, if it’s not already. One only has to look at the European situation to understand how difficult it is to find a consensus and the debt ceiling clash in the US is even more glaring.
We’ll dare to name a few potential – if not that radical – flash points: Japan/Korea, BRL heading an EM block vs. the dollar and the classic CNY vs. USD, something US politicians might actually be able to unite on.
Related articles
- ECB acts to ease euro zone tensions (theglobeandmail.com)
- Yen Plunges as Japan Intervenes in Market First Time Since March (businessweek.com)
European and US stresses starting to have a more notable impact on currency markets with the SNB on Wednesday surprising by cutting its target interest rate from 0.25% to ‘as close to 0.0% as possible’ in a move designed to soften the CHF and this has been followed up in Asia with new Japanese steps – the BoJ announcing a further expansion of its asset purchase plan and more forcefully intervening again in the forex market, forcing USD/JPY back towards 80.00.
Japanese authorities have been keen to weaken the JPY ever since March’s earthquake with a view to cushion the blow faced by exporters, which prompted the first coordinated G7 intervention since authorities moved to shore up the Euro back in 2000. But recent yen price action has not been a Japan specific affair but rather driven by others ills, specifically the European debt crisis and US debt/growth stresses. A successful turnaround of the longer-term JPY trend then requires not just steps from Japanese officials but a resolution of the fundamental risks emanating from Europe and the States. It can’t be solved by intervention.
The real issue for Japan is probably the on-going dominance of exchange rate pegs in Asia which places disproportionate stresses on the convertible currencies. The Chinese are clearly the prime offenders but the list is lengthy. One only has to look at JPY/KRW and the divergent fortunes of Sony and Samsung during the recovery to see our point. The JPY itself is not particularly overvalued as the chart below highlights, the Swiss have a far more compelling case and both look cheap compared to the mighty AUD. What really stands out is that before the financial crisis the JPY was cheap, a function of it’s then unique funding currency status.
Japan has never been renowned for its radical solutions – which would be needed to have a sustained impact on the JPY – and it’s doubtful we’ll see anything now given the dire state of the country’s politics. More intervention might be forthcoming but with risks in global markets on the up we don’t see this as a game changer currently. The liquidity provided by the BoJ then should be viewed opportunistically, with higher levels in USD/JPY offering attractive entry levels. We’d also note the EUR/JPY downtrend remains in place below the 113.90/114.50 resistance band. These trades should work on a number of levels, firstly risk aversion should encourage further repatriation from Japanese investors, both from the unwind of higher beta carry trade and stock bets but also from narrowing rate differentials, a consequence of falling UST yields. Secondly, slowing US growth could prompt the Fed into taking fresh action. Any further round of quantitative easing (the only tool as its disposal) would clearly be a dollar negative. Euro problems compound the pressures, the EUR’s previous safe haven status being vastly reduced by the peripheral debt crisis and growth data from the core looks to be softening up too.
Related articles
- USD/JPY: BOJ likely to discuss intervention at this week’s policy meeting (forexlive.com)
- More On The 2011 Edition Of US-Japan Open Currency Warfare: “This Is Just The Beginning” (zerohedge.com)
