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When risk aversion spiked in August, after China’s devaluation of the renminbi, the result was an all-too-familiar flight to safe-haven currencies.
Kit Juckes, macro strategist at Société Générale, says: “The August winners in FX-land are the currencies of countries which import oil and have the least scope to ease monetary policy further, or at least those where there is the least scope to surprise markets with further easing.”
G10 v USD |
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Source: Société Générale |
Exhibit A: the yen. The hammering of the global equity markets and general decline in risk appetite has seen yen outperform other G10 currencies in recent weeks, registering a near 3% rally in August against the dollar. Having traded as low as 125.9 at one point in August, its lowest value since 2002, the yen has more recently hovered around the 120-mark against the dollar, and also strengthened against the euro.
In fact, August was the most volatile month for the currency since February 2009, says Eric Theoret, FX strategist at Scotiabank. USD/JPY declined 6.0% on an intraday basis, registering its high on August 21 and its low on August 24, in response to panic fuelled by a rout in the equity markets and the broader problems emanating from China.
The Commodity Futures Trading Commission net-short position narrowed by $6.4 billion to $4.1 billion through the two weeks ending August 25, he says.
Heightened volatility
This heightened volatility reflects the fact the yen has been under pressure from external and internal factors, but clearly external factors were the principal driver. On the face of it there is nothing surprising about this: in times of global risk aversion, investors have traditionally retreated to the familiar sanctuary of this Asian safe haven.
However, the BoJ will be disappointed to see all the work it has done with QE to weaken the currency undone at a stroke. The question now is, with uncertainty still rife about the forthcoming decision on rates from the Fed, and the outlook for the Chinese economy, is the yen set for further strengthening?
Conventional wisdom would suggest so.
Daiju Aoki, economist at UBS, says: “If a slowdown in the Chinese economy triggers a risk-off global market, the yen is likely to be bought as a safe asset, leading to yen appreciation against the renminbi, alongside appreciation against the dollar and euro.”
However, Aoki believes the BoJ will do what it can to re-establish yen weakness if market sentiment continues to push up the yen.
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Takahiro Sekido, BTMU |
Takahiro Sekido, Japan strategist at Bank of Tokyo-Mitsubishi UFJ (BTMU), concurs, adding: “We doubt yen gains will be sustained and given the degree of BoJ monetary easing and the need for the yen to remain weak, we expect strong support for USD/JPY to ensure limited further declines from current levels. “Our sense is that the scale of the move reflected positioning and that once positioning becomes more neutral, the upside for the yen will become much more limited.”
If global market sentiment pulls yen one way, and the BoJ endeavours to pull it another, the outcome is likely to depend on the scale of the crisis creating the risk aversion.
“In the case of a serious crisis from China, akin to the financial crisis, the BoJ and ministry of finance might not be able to stop yen appreciation,” says Aoki at UBS. “But this is not our main scenario.”
So far, the BoJ has kept its monetary stance broadly unchanged, maintaining its commitment to raising the monetary base by ¥80 trillion annually, but BTMU’s Sekido believes market turbulence will force the BoJ back to the monetary-easing table.
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Source Scotiabank |
It is not just the turn in sentiment that will concern the BoJ. China’s fortunes have a direct impact on Japan, especially via trade, with China taking more than a quarter of Japan’s total exports – or around 18% on a value added basis, second only to the US. Aoki estimates “a 1% slowdown in China’s real GDP growth would depress Japan’s real GDP by about 0.3%, mainly as the direct impact is compounded by the indirect impact via third countries and by forex.”
Internal factors have also contributed to yen volatility. Real GDP contracted by 0.4% quarter-on-quarter in Q2. Private consumption fell 0.8%, while inventory build-up suggests growth might not rebound quickly, even when consumption picks up.
Inflation has again fallen to low levels, with the devaluation of the renminbi having already triggered speculation the BoJ will miss its 2% inflation target.
“This latest deflationary shock to the global economy is likely to increase pressure on the BoJ to take further easing measures,” says Sekido.
The BoJ appears to be relaxed.
Yujiro Goto, senior FX strategist at Nomura, says: “Governor [Haruhiko] Kuroda said high-frequency data such as the UTokyo daily price index point to clear price increases on a year-on-year basis so far this fiscal year.
“Even though economic momentum weakened in Q2, while the market has been volatile since the previous meeting, Kuroda’s optimistic view has not changed materially yet.”
Further reading |
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Yen strength is therefore likely to prove temporary, and the weakening trajectory that had been in place leading into the summer will be resumed.
Scotiabank’s Theoret says: “We maintain a fundamental, central bank policy-driven forecast for USDJPY with a Q4 2015 target of 125 and further weakening to 131 by the end of 2016.”
Yen should also weaken against the euro, says Lydia Kranner, financial analyst at Raiffeisen Bank, adding: “The yen should depreciate to about 140 over the next six to nine months, given our EUR/USD estimates.”
However, sounds of discontent about the progress of Abenomics are getting louder. Critics point out that real wages have remained stagnant for the past two years – or have declined, if you take into account the inflationary impact of the sales tax. GDP, after all, has shrunk.
A growing number of observers are also asking how Japan can become richer by making its citizens poorer via a weakening currency. It seems supporters of Abenomics have little response other than to call for more time.
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