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1 Feb 2016
JPY: BoJ easing boosted risk sentiment & appeal of the USD - MUFG
FXStreet (Delhi) – Lee Hardman, Currency Analyst at MUFG, suggests that the yen has remained on the defensive undermined by last week’s decision by the BoJ to introduce negative interest rates which has prompted the trade-weighted yen to almost fully reverse its sharp gains recorded from earlier in the month.
Key Quotes
“The BoJ’s decision to introduce negative rates was clearly a surprise which has helped to reinforce the initial market reaction to the policy announcement. Japanese government bond yields have fallen sharply moving into negative territory as far out as eight years in maturity. The favourable market reaction at least initially backs up the BoJ’s view that a negative interest rate is expected to exert its intended effects on financial markets even under the multi-tier system where a negative rate is applied only partially.
The subsequent reduction in interest rates in Japan is expected to further encourage Japanese investors to increase exposure to riskier assets leading to yen weakening capital outflows. The negative interest rates will also undermine the safe haven appeal of the yen which recently had become the safe haven currency of choice early this year. The combination of negative interest rates and QE adopted by the ECB proved effective at sharply weakening the euro which has persisted at weaker levels as well.
However, we believe that the BoJ’s decision to implement negative rates alongside QQE will have a more modest weakening impact on the yen. The yen is already significantly undervalued, even more so than the euro, which will dampen the scope for further weakness. According to our long-term estimates we believe that the yen is already between 15% and 20% undervalued against the US dollar. In contrast, when the BoJ first introduced QQE and then extended QQE the yen was significantly overvalued and around fairly valued respectively. It supports our view that further BoJ easing is likely to have a diminishing weakening impact on the yen.
In contrast, the relative appeal of the US dollar has been boosted further by looser monetary policy overseas. Already this year the ECB has signalled strongly that it is likely to ease policy further in March and the BoJ has followed the ECB in adopting negative interest rates. Whereas the Fed remains committed to monetary policy normalization in the coming years even if it the pace of tightening is more gradual.
The latest GDP report from the US revealed that the economy lost some growth momentum in the second half of last year. However for the year as whole it expanded for the second consecutive year by 2.4% in 2015. Modest above trend growth has resulted in a further tightening in labour market conditions. The strong US dollar and an inventory correction have undermined growth in the second half of last year.
Overall the US economy is still doing reasonably well considering the external headwinds to growth. Personal consumption had its strongest year of growth since 2005 boosted by lower oil prices. The stimulative impact of lower oil prices has not been felt fully yet too as US households have also used the income windfall to increase savings which could be run down in the year ahead. Unless there is a sharper and/or sustained economic slowdown in the US which could prompt a U-turn in Fed policy, the US dollar is likely to remain relatively attractive.”
Key Quotes
“The BoJ’s decision to introduce negative rates was clearly a surprise which has helped to reinforce the initial market reaction to the policy announcement. Japanese government bond yields have fallen sharply moving into negative territory as far out as eight years in maturity. The favourable market reaction at least initially backs up the BoJ’s view that a negative interest rate is expected to exert its intended effects on financial markets even under the multi-tier system where a negative rate is applied only partially.
The subsequent reduction in interest rates in Japan is expected to further encourage Japanese investors to increase exposure to riskier assets leading to yen weakening capital outflows. The negative interest rates will also undermine the safe haven appeal of the yen which recently had become the safe haven currency of choice early this year. The combination of negative interest rates and QE adopted by the ECB proved effective at sharply weakening the euro which has persisted at weaker levels as well.
However, we believe that the BoJ’s decision to implement negative rates alongside QQE will have a more modest weakening impact on the yen. The yen is already significantly undervalued, even more so than the euro, which will dampen the scope for further weakness. According to our long-term estimates we believe that the yen is already between 15% and 20% undervalued against the US dollar. In contrast, when the BoJ first introduced QQE and then extended QQE the yen was significantly overvalued and around fairly valued respectively. It supports our view that further BoJ easing is likely to have a diminishing weakening impact on the yen.
In contrast, the relative appeal of the US dollar has been boosted further by looser monetary policy overseas. Already this year the ECB has signalled strongly that it is likely to ease policy further in March and the BoJ has followed the ECB in adopting negative interest rates. Whereas the Fed remains committed to monetary policy normalization in the coming years even if it the pace of tightening is more gradual.
The latest GDP report from the US revealed that the economy lost some growth momentum in the second half of last year. However for the year as whole it expanded for the second consecutive year by 2.4% in 2015. Modest above trend growth has resulted in a further tightening in labour market conditions. The strong US dollar and an inventory correction have undermined growth in the second half of last year.
Overall the US economy is still doing reasonably well considering the external headwinds to growth. Personal consumption had its strongest year of growth since 2005 boosted by lower oil prices. The stimulative impact of lower oil prices has not been felt fully yet too as US households have also used the income windfall to increase savings which could be run down in the year ahead. Unless there is a sharper and/or sustained economic slowdown in the US which could prompt a U-turn in Fed policy, the US dollar is likely to remain relatively attractive.”