Yen Trends Retrace as the Bank of Japan Awaits

2016-12-19 14:36:00

Talking Points:

- This week’s economic docket is relatively-light, with the one ‘big’ event tonight’s Bank of Japan rate decision. No movement on rates is expected; but will the BoJ look to upgrade economic forecasts so quickly after the start of the Trump rally, which is just a little over six weeks old?

- How aggressively the BoJ is managing rates given their recent shift to Yield-Curve targeting could have a profound impact on near-term price action in Yen-related markets; and while recent moves in Japanese markets have been profound, we’re at deep-overbought levels in many key areas.

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The big item on the economic docket for this week takes place tonight at the Bank of Japan’s rate decision. No moves are expected on rates and there is probably little chance of seeing any new commentary or themes from the BoJ. Even the one potential event that may take place is probably low-probability type of event, and this is whether or not the BoJ is ready to upgrade economic assessments after the post-Trump rally has brought life back to Japanese markets over the past six weeks.

Chart prepared by James Stanley

We looked into this topic in our Trading Forecast for this week on the Yen entitled, The BoJ’s Pain has Quickly Reversed. But Will They?

The stance of the Bank of Japan has been rather clear: They are dovish and accommodative and after they re-formatted the way that the bank will do QE at their September meeting, they have considerable flexibility in how they want to look to implement bond purchases in the future. That change was key – as before the BoJ was purchasing a set volume of bonds each month and in that September-swap, they changed their focus from the amount of bonds purchased every month to targeting the yield on the 10-year Japanese Government Bond.

But more helpful to the Japanese economy than this QE-shift from the BoJ in September was the election of Donald Trump as President of the United States. The BoJ had put-in considerable efforts to weaken the Yen in the ten months prior to the election; with each effort falling flat. The BoJ even went so far as to, surprisingly, move to negative rates in the effort of driving capital out of the Yen. And that worked for one single day. But in the months following, that move to negative rates blew-up on the Bank of Japan as the Yen only continued to strengthen, and the Nikkei continued to sell-off even more.

Chart prepared by James Stanley

This put the BoJ in the odd position for a Central Bank of having their backs against the wall. Would a deeper cut to negative rates only serve to elicit even more risk aversion? And if so, what could the BoJ do to actually weaken the Yen in the effort of helping exporters? The post-Trump rally has seen the return of the ‘reflation’ trade as markets are pricing-in some form of fiscal stimulus on the basis of a Trump administration; and this has brought considerable weakness to the Yen as the prospect of tighter rate policy in the United States has brought-upon the expectation for continued monetary divergence between US and Japanese economies.

This has led to a run-higher in USD/JPY of as much as 16.9% from the lows of election night; and this Yen-weakness has helped to drive the Nikkei-higher by 21.33%. This is a veritable gift for the Bank of Japan, as the BoJ had put-in considerable efforts to try to do the same, including negative rates, only to fail.

Chart prepared by James Stanley

But now that the BoJ has this ‘gift,’ are they going to look to upgrade economic assessments which could potentially begin to reverse the rally? Below, we look at three potential support levels for traders to investigate longer-term entries should weakness develop in USD/JPY around this BoJ meeting.