Yen’s Gains to Extend as BoJ Stands Pat, Fed Tapers Less than Expected
Fundamental Forecast for Japanese Yen: Bullish
The Japanese Yen was the top performing currency this past week, gaining +3.45% against the US Dollar, with the USDJPY closing at ¥94.10, the lowest level since April 4, the day the Bank of Japan announced its sweeping QE measures that ultimately propelled the pair through 100.00 within four weeks. Although the Yen weakened through Monday following the May US labor market report beat on June 7, the BoJ’s policy meeting on Tuesday failed to produce the necessary result to put the Yen back on the schneid: measures to address recent JGB volatility.
The BoJ’s May meeting Minutes released on Thursday, although containing stale information from the pre-Nikkei rout period (which began on May 23), showed that the central bank wasn’t concerned at all with pending volatility in Japanese financial instruments. However, in what was prescient commentary, at least one member said that recent policies risked provoking volatility in bond markets due to unrealistic expectations. This view was met with opposition that the BoJ’s large scale asset purchases would keep downward pressure on yields. At this point, we know now that this single member was correct; but the collective opinion reigns, meaning that no new measures should be expected - and that any short-term liquidity measures would more-or-less amount to a Japanese-styled LTRO (of the ECB in December 2011 and February 2012), which may not be enough to end recent anxiety.
Truly, at this point in time more than ever, the BoJ is one of two domestic fundamental factors that are influencing the Yen, the other being ‘Abenomics.’ In its current iteration, ‘Abenomics’ is on hold, in so far as recent 1Q’13 GDP figures were revised higher, and Japanese diet elections in mid-July, given the controversy around 'Abenomics,' he's unlikely to push new measures before then. At this point in time, it makes little sense that Japanese Prime Minister Shinzo Abe would spend the political capital when he can wait a few more weeks after his party wins the diet elections.
With respect to the USDJPY specifically, the Federal Reserve’s June 19 meeting will undoubtedly produce excess volatility in the pair, given the speculation surrounding the state of QE3. Ahead of the Wednesday meeting, it’s evident that the market is pricing in a fairly sharp slowdown in QE3 - perhaps seeing the program wound down by $25B to $35B. This expectation appears excessive given subdued core inflation pressures and labor market growth at only a modest pace. (The 3-month, 6-month, and 12-month averages all dropped as a result of the May NFPs print.) If there's a reduction in QE3, it will be much smaller than market anticipants are pricing in; anything less than $15B could lead to a rally in US Treasuries in the short-term, putting further pressure on the USDJPY.
Elsewhere, the commodity currencies – the Australian, Canadian, and New Zealand Dollars – remain under fire due to the increasingly negative outlook on Chinese growth, which sees no signs of abating in the near-term. But for market positioning for the commodity bloc – market participants are extremely short – a greater pullback in the AUDJPY, CADJPY, and NZDJPY is a reasonable expectation at this juncture, although range trade conditions could be present this week as commodity bloc positioning moderates and the Yen rallies following the Fed’s rate decision on Wednesday.
In terms of the European currencies versus the Yen, the EURJPY looks the weakest amid widening periperhal-to-core bond yield spreads, notably the widening of Italian-German and Spanish-German differentials since the European Central Bank’s Rate Decision on June 6. European equities closed down for the fourth consecutive week, calling for a greater correction in the Euro. Overall, the tone here is clear: the ‘risk off’ nature of the market is spreading quickly, and the conditions have aligned for further Yen strength going forward.
--- Written by Christopher Vecchio, Currency Analyst
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