Fundamental Forecast for Japanese Yen: Neutral
- Everything that was supposed to help the Yen last week came out worse than expected.
- Cooling Syrian tensions amid a surprise deal between Russia and the US significantly reduced risk profile.
- A significant drop in US yields could prop up the Yen if the Fed’s QE3 taper disappoints.
The Japanese Yen was the worst performing currency this past week, dropping by -1.91% to the top New Zealand Dollar, another -1.83% to the British Pound, while only a mere -0.27% to the US Dollar. Last week in this forecast I said “with the domestic tone shifting for Japan, it will be necessary for incoming growth and inflation data to remain buoyant in order for the Yen to enjoy further reprieve.” Clearly, this was not the case.
Indeed, the misses on the 2Q’13 GDP reading set the tone for a weaker Yen right from the start of trade in Asia on Monday, as signs of a weaker than expected economy leave open the door for speculation on additional easing by the Bank of Japan. As noted last week, a considerable factor for any forecasted Yen strength hinged on these growth readings besting expectations.
With the economy chugging along at an acceptable pace nevertheless (+3.8% annualized versus +3.9% expected), further chatter emerged about the prescribed sales tax hike due in the 2Q’14, with BoJ officials purportedly endorsing the fiscal measures and even offering monetary assistance should the economy see pressure. Additionally, to help offset the drawdown in consumption, the Japanese government is considering a corporate tax cut to help balance out the sales tax hike impact. In light of the fact that overall consumption here suffers – accounting for approximately 60% of Japanese GDP – these fiscal adjustments are perceived to be net-negative for the Yen.
Compounding the shakier than expected domestic picture have been positive developments on the geopolitical stage, with Russia and the US agreeing to peace talks in Geneva, Switzerland, to figure out how to strip the Syrian regime of chemical weapons. As we’ve seen over the past few weeks, any progress that reduces the threat of US military intervention has been perceived as “risk positive,” in that stocks have rallied alongside the US Dollar, while the Japanese Yen, crude oil, and precious metals have fallen. Should these tensions remain in their current state or ease further, they will likely be another negative influence for the Yen.
With little important data on the Japanese economic calendar for the coming week – only the August Trade Balance figures and the weekly domestic/foreign flow of stocks/bonds figures are of interest, and they haven’t generated truly significant price action – attention turns to the highly anticipated Federal Reserve September meeting this Wednesday.
According to consensus estimates compiled by Bloomberg News, economists are calling for a $10B reduction in the pace of QE3, with the cuts coming to Treasuries purchases, from $45B to $35B. The pace of mortgage-backed securities (MBS) purchases will remain on hold at $40B. We see the risk of a cut of $15B in Treasury purchases, which might spark a US Dollar rebound (to the Yen’s detriment). But if the cut is only $10B, and Fed Chairman Bernanke uses the press conference to reestablish forward guidance – which has been weak considering US yields are hovering near two-year highs (pre-US losing its ‘AAA’ rating) – there is a chance for a Yen rally.
The Fed is keenly aware of the risks of a 1994-esque bond market meltdown, caused by the successive, linear pace of Fed policy tightening. Accordingly, to avoid such sentiment from evolving, Chairman Bernanke and the Fed are likely to emphasize that the reduction in QE3 will be in sporadic increments, depending on incoming US economic data. The most recent NFPs, Advance Retail Sales, and Consumer Confidence reports suggest that only a minor reduction in QE3 is appropriate.
Ultimately, the Yen is at risk for further weakness, but a more dovish Fed – to balance out markets’ hawkish interpretation given bond market dynamics across the global – leaves open the door for a mid- to –late-week rally in the Yen against the US Dollar should US yields take a step backwards this week. –CV