USD/JPY Higher on BOJ's 'Shock and Awe' Policy - Will it Last?
- Recently BOJ Governor Kuroda said negative rates were unlikely.
While the economic focus of the day is the Q4'15 US GDP report, markets are in a flurry thanks to surprise easing from the Bank of Japan. After Governor Kuroda just weeks ago told a group of parliamentary lawmakers that it was unlikely that the BOJ moved forward with more easing or lower rates, the BOJ did just that, joining the ECB and others in the negative interest rate policy (NIRP) club.
At first blush, markets, of course, are excited by the news of more 'stimulus.' But is this really stimulus - do we need lower rates at a time when the main concern is dissipating global liquidity? Probably not. And therein lies the rub for the BOJ's decision: it did not change the pace of its asset purchases, keeping that on hold at ¥80 trillion per year.
The question we're seeking an answer to - "if the BOJ didn't expand its liquidity provisions, were these efforts aimed at helping the real economy or simply constructed to have an impact on financial markets?" - is immediately self-evident. By dropping rates lower, the BOJ has incentivized market participants to shift their risk preferences; investors need to take on greater risk in order to capture the same returns. As JGB yields fall, Japanese equities look relatively more appealing; and the Yen suffers. This is the immediate impact witnessed overnight.
Beyond the short-term impact, however, by implementing policies that clearly target the Japanese Yen exchange rates, the BOJ has effectively implemented a competitive devaluation policy. As recent history has illustrated, it's highly likely that other major global manufacturers - particularly those in Asia - will respond with their own "easing" efforts as well.
The main concern of course is China. If the PBOC responds by devaluing the Chinese Yuan again, it would be highly likely that markets simply do their best impressions of August 2015 or January 2016: the US Dollar gains broadly; commodity prices are pushed down; ST yields rise, pushing up funding costs and blurring the lines between illiquid and insolvent; and the resulting aggregate jump in credit risk pushes down asset prices (particularly equities) globally. Markets are starved for liquidity (more QE), not overvalued fixed income assets (resulting from lower and now negative rates). If this is the BOJ's plan, it seems destined to fail; the question is just how fast markets will get wise to the charade and drive the Yen higher again.
These aren't new concerns, of course. You may recall my article in Markit Magazine from the summer of 2013, "FX War Games" discussing the Fed's QE and the issues the friction in the CNY/JPY exchange rate were causing for the globe. More recently, in early-January, Mexican Finance Minister Luis Videgaray Caso said that China's actions with the Yuan threatened to kick-off a global competitive devaluation cycle. It seems the BOJ's actions today have signaled just that.
--- Written by Christopher Vecchio, Currency Strategist
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