The Alchemy of Turning a Negative into a Positive
Fundamental Forecast for JPY: Neutral
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The Yen has put in a significant movement so far on the day, weakening against the US Dollar by as much as 2.32%; and this is the largest movement of weakness in the Yen since January 29th, when the currency weakened by 2.7% against the Greenback after the Bank of Japan had, surprisingly, made the move to negative interest rates at the January BoJ meeting.
But that movement to negative rates hasn’t worked out too well so far, has it? The move to negative rates was likely a pre-emptive one designed to disincentive capital flows from being driven into Japan and the Yen. With Europe already deep into negative territory, the Federal Reserve taking on a ‘less hawkish’ stance and China on the verge of what could’ve quickly become a hastened slowdown enveloping the economy, the Bank of Japan saw the risk of exuberant risk-aversion flows strengthening the Yen; which threatened to undo the past three years of policy-driven movements in the Yen and the Nikkei.
So, the Bank made the move to negative at their January meeting on the 29th, and what they feared ended up happening anyways: The Yen strengthened massively and the Nikkei took a nasty turn lower. As a matter of fact, the case can even be made that the surprising nature with which the bank had acted actually contributed to the increase in panic-prone risk aversion.
The source of this morning’s weakness is on the back of an incredibly salient report that alludes to the fact that the Bank of Japan may be debating negative interest rate loans; in a similar vein to the recently enacted policy from the European Central Bank. In January, the Bank of Japan imposed negative rates on excess reserves held at the Central Bank, but if this morning’s report comes to fruition, that program would be expanded along with a deeper cut to negative rates, to offer loans to banks bearing negative rates.
Negative rates on excess deposits are, in essence, a cost for a bank; but if that same bank is offered a loan with a negative-rate from the Central Bank, that’s kind of like amortization in an asset. The negative rate on the outstanding balance decreases the loan balance; and if that bank could also make money by loaning the funds to credit-worthy borrowers, this can be thought of a form of two-way stimulus, and the bank can actually make money in both directions; on the negative rate from the Central Bank amortizing the outstanding loan balance simply from the negative rate, as well as the rate spread of what has been loaned to borrowers.
The longer-term question behind such a policy; and this isn’t just relevant for the potential policy being floated by the Bank of Japan but also for Europe, is whether such a program will actually help to create demand for loans, which is kind of the actual problem here (and in Europe). And, unfortunately, it’s going to take quite a bit longer than the one month of evidence that we have (out of Europe) so far to be able to make a probabilistic assertion. This could and should certainly give the Bank of Japan reason enough to take a step back to evaluate matters more fully before embarking on yet another aggressive policy move.
The one thing that is certain is that the Yen is primed for volatility. The prevailing trend is and has been one of Yen strength, and all factors held equal, this wouldn’t be an outlandish expectation for the next couple of weeks. But given this morning’s report, which obviously came from someone very close to the Bank of Japan’s discussions, anything can happen when the BoJ meets next week. And just as we saw when the ECB enacted such a policy, it would be impossible to say definitively that the Yen would strengthen or weaken on the back of such an announcement.
Due to the incredibly opaque nature around the Yen after this morning’s burst of weakness as well as this widely circulated report; and given the fact that we’re essentially watching the Bank of Japan make Neo-Keynesian history, we’re holding a forecast of neutral on the Japanese Yen.
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