Bank of Japan follows suit and eases monetary policy but the yen remains strong

 Last night’s monetary policy decision from the Bank of Japan saw further support provided to the Japanese economy. The BoJ added to its existing asset purchase programme by Y10trn, taking the total purchases to Y80trn. This Y10trn increase has come earlier than many expected and was certainly more than most market players expected. BoJ also extended the deadline for the end of the programme by six months to the end of 2013.

Nerves over the global economy are a major factor behind the BoJ’s decision. The US recovery remains shaky, the risks of a Chinese hard landing are rising, while there is little doubt that the eurozone has not seen the worst of the current economic contraction.

Global conditions have contributed to what the BoJ has described as a “pause” in the domestic Japanese economy. BoJ Governor Shirokawa has said the Japanese recovery has been set back by six months thanks to a prolonged global economic slowdown. Exacerbating the domestic growth outlook is the fact that a territorial dispute between China and Japan threatens to disrupt trade relations, something Japan can ill-afford.

Also in the BoJ’s mind will be the desire to curb the appreciation of the yen, which is hurting the Japanese economy. Particularly in light of the US Federal Reserve at last announcing QE3 this month, another move from the BoJ was always likely. However, the yen hasn’t weakened off today as much as the Japanese official would have liked. It has retraced almost all of last night’s losses, which demonstrates that there is no guarantee that QE will weaken a currency. 

Richard Driver

Currency Analyst

Caxton FX

NOK/JPY Overview and Outlook for 2012

The Norwegian krone has made an extremely impressive start to 2012. It was the top performing currency in February, which is largely due to a combination of domestic economic strength and soaring oil prices.
Amid worrying developments in Iran, the price of Brent crude oil is trading at what is more than a three year high of $126 per barrel, which represents a 15% climb since the start of the year. As a major producer of oil, the Norwegian economy stands to benefit and by association so too does its currency.

On a domestic level, Norwegian manufacturing and retail sector growth and declining unemployment has improved sentiment towards the NOK, while a widening trade surplus shows that its export sector is not being hit by the eurozone downturn as other economies are. The Norwegian economy grew by an impressive 0.6% in the fourth quarter of 2011 and forward looking surveys are pointing towards a quicker pace of growth in 2012. Amid rising investment in Norway’s oil and gas sector, growth seems firmly underpinned while other global economies face a very uncertain year. As such, Norway’s stable, AAA-rated economy has seen the krone take on the role of something of a safe-haven currency so far this year.

The only real question mark hanging over the Norwegian krone is the monetary policy of the Norges Bank. The state of Norwegian economic growth wouldn’t suggest the need for interest rate cuts but that is what we have seen this week. The Norges Bank has surprisingly followed its December rate cut of 0.50% with a further 0.25% cut. With the Norwegian base rate currently standing at 1.25%, the krone’s interest rate differential has clearly been heavily reduced. More significantly though, the move suggests that the Norges Bank is very concerned with the appreciation we have seen in the Norwegian krone. A further cut to the base rate this year cannot be discounted.

Despite the NOK’s minor sell-off in response to the Norges Bank’s move this week, NOK/JPY has climbed by over 14% from January’s lows of 12.65, to its current level of 14.45. High oil prices and strong growth are likely to sustain demand for the NOK moving forward. The Norges Bank’s discomfort with the krone’s appreciation will slow the pace of this pair’s climb (and regardless, it is highly unlikely that the yen can also maintain its current pace of depreciation). Nonetheless, NOK/JPY should see gains past 16.00 in the second half of this year.

Richard Driver
 
Currency Analyst
 
Caxton FX

EUR/JPY Overview: Japanese yen to continue weakening

The yen has weakened off by around 11.5% against the euro in the past two months. This is largely attributable to the convergence of performance between the US and Japan economies and monetary easing from the Bank of Japan.

The Japanese economy remains a key underperformer among the major global economies; it contracted by 0.2% in the final quarter of 2012 (though this was revised up from an initial estimate of a 0.6% contraction). Reduced exports, caused by the yen’s excessive strength and weakening global demand, are a key factor weighing on Japanese growth. However, industrial production and the post-earthquake reconstruction project is gaining pace, which should take Japanese back into positive territory this quarter.

The market was recently dealt a scare by January’s Japanese current account data, which revealed a record deficit of $5.41bn. The yen suffered as a result - Japan’s current account surplus has been a cornerstone of the JPY’s safe-haven status. Nonetheless, it remains likely that this deficit will prove a temporary blip, though it did the yen no favours in the short-term.

The US economy, by contrast, is outperforming. It grew at an annualised pace of 3.0% in the final quarter of 2011. As shown by the Non-Farm payrolls figures so far this year, the US labour market is making some real improvements. Crucially, this has seen the US Federal Reserve remove any reference to QE3 from its messages and in a statement this week, it upgraded its economic outlook from “modest growth” to “moderate growth.” With China slowing down, the eurozone entering a recession and Japanese growth likely to be fairly flat this year; the US economy is the real outperformer at present and we are seeing considerable yen to dollar flows as a result.

Another key factor weighing on the JPY is the Bank of Japan’s commitment to yen-depreciation. The strong yen has been a huge downside factor on Japanese exports. The Bank of Japan has repeatedly failed in its attempt s to directly intervene in the currency markets but monetary easing is still a weapon that the market is wary of.

February saw the BoJ boost its quantitative easing programme by 10 trillion yen, which has fuelled much of EUR/JPY’s gains in the past month. Whilst the BoJ took no further major action at its March meeting, the dissent within the committee highlights the scope for further easing. The Bank of Japan is highly concerned with the country’s deflation problem and is likely to continue monetary easing this year in order to achieve its 1.00% inflation target.

There are a plethora of reasons why not to invest in the euro this year. Having contracted by 0.2% last quarter, the eurozone’s growth figures in the year so far are pointing quite clearly to a recession. Nonetheless, there have been some broadly positive developments out of the eurozone in recent weeks, with the Greek debt-swap deal going through and paving the way for what is likely to be a second Greek bailout. However, sentiment towards the euro has been hit hard, as shown news by the 13.5% decline in the EUR/USD pair from last summer’s high.

Greece will be granted aid for now but it is widely expected to return to bailout territory by next year. Market sentiment remains suspicious that Portugal and more alarmingly Spain and Italy may be forced to follow a similar path in having to restructure their debt. The only real factor seemingly supporting the euro at present is the constant need of Asian and Middle Eastern central banks to diversify their FX reserves away from the US dollar.

Regardless of the eurozone’s poor growth and debt dynamics, monetary policy in Japan is likely to be the dominant driver of this pair in 2012 and EUR/JPY’s rise will not be a symptom of euro strength but of yen weakness. Long positions in the yen have fallen back considerably from January’s highs and we do not view the weakening bias we have seen in the yen in the past few to be temporary.

Developments in the eurozone and the US economy have provided a boost to global stocks, including the Nikkei, and in these risk-on conditions the safe-haven yen will always weaken. Events in the eurozone are likely to put plenty of pressure on market risk appetite this year but our bet is that the BoJ will successfully demonstrate its resolve in weakening the yen through monetary easing, something it failed to do through direct intervention.

We can see the EUR/JPY rate continuing its uptrend from the current 109.00 level in the coming months. This should see April 2011’s highs above the 120.00 level revisited at some point in the second half of this year.

Richard Driver
Currency Analyst
Caxton FX

Can the Bank of Japan's curb the yen's strength?

The Japanese economy is in recession, it is still recovering from a devastating natural disaster, Japan’s interest rate is at rock bottom and what is more, Moody’s has just downgrades Japanese debt. So why has the Japanese yen strengthened to record levels in recent weeks and months?


The answer is simple: the yen’s safe-haven status. The past six months have thrown up a huge amount of uncertainty in the financial markets. The Japanese earthquake disrupted international trade patterns, oil prices are sky high, global growth has slowed down, the eurozone debt crisis threatens the global banking system, and the US has had its debt downgraded and could be heading into another recession.

What do investors do in this climate? Head out of riskier assets such as commodity-linked currencies and equities, and into traditional safe haven assets such as government bonds (such as UK or US, not Greek!), gold, and the yen and swiss franc. The fact that the Japanese economy is struggling matters not a jot, the yen’s safe-haven status trumps all.

Turmoil in the financial markets looks unlikely to let up any time soon; it will probably take months for a long-term solution to the eurozone debt crisis to emerge, not to mention the increasing likelihood of a US recession and further debt downgrade next year. So what can stop the yen from strengthening?

Certainly the Japanese government and the Bank of Japan are very uncomfortable with the yen at current levels. There has been much jawboning about intervention in the currency markets in order to weaken the yen. The Bank of Japan conducted some unilateral intervention on Aug 4th, injecting around $3bn into the Japanese economy. Going on the yen’s climb in the time that has passed, this was unsuccessful.

Japan has very recently announced a $100bn credit line to encourage domestic firms to sell yen and invest overseas. Japanese officials may be coming to terms with the fact that they cannot to disrupt the yen’s longer-term strengthening. Further intervention efforts can be expected however, if for no other reason than to slow the yen’s appreciation. 75 yen to the dollar may well be the next benchmark which triggers further action from the Bank of Japan.

Richard Driver
Senior Analyst – Caxton FX


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Japan’s earthquakes (Kobe 1994 and Tohoku 2011): the effect on yen

One month on from the Japanese natural disaster on March 11th, we saw this as an interesting opportunity to compare the currency market’s response with the earthquake that struck back in 1994.

On January 17th 1994, a 7.3 magnitude earthquake hit Kobe; killing over six thousand people and causing ten trillion yen worth of damage (amounting to roughly 2.5% of Japanese GDP). The yen proceeded to strengthen by 18% against the US dollar in the space of three months, before almost halving in value in the subsequent three years.

So how does this compare to yen’s response to this most recent disaster?

The Japanese currency did appreciate, but only by 5% against the greenback and in the space of just 5 days. This climb was reversed within the following five days as the world’s G7 Central Banks intervened to curb further yen appreciation. Since that date the yen has continued to steadily lose value as the market picks up on the lower growth potential and the expectation of rock bottom interest rates in Japan for some time to come. Indeed the yen is currently down at a 7-month low with further room to drop.

The natural market response (yen investment) in the wake of last month’s earthquake was cut well short by the unprecedented and prompt Central Bank intervention. In the current climate, the Bank of Japan is simply unwilling to allow its already weak economy to suffer the serious knock to its exports that a stronger yen would amount to. Obviously we are yet to find out whether the yen will devalue to the same extent as in the late 1990s, but the current forecast is for continued depreciation on the basis of weak fundamentals.

The USD/JPY rate currently sits at 85 yen. Forecasts 12 months out expect to see the US dollar reach 100, but the 144 level reached in 1998 does at this point seem very far-fetched, particularly as the Fed are hardly in a hurry to tighten monetary policy either.

Richard Driver
Analyst – Caxton FX


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Japan announces a major round of quantitative easing: how will the yen fare in response?

Reacting to the devastating impact of the earthquake that struck on Friday, the Japanese central bank has announced its intention to pump a record ¥15tn into the economy ($183bn). This follows the reaction of the Reserve Bank of New Zealand to the earthquake that struck Christchurch, which opted to cut rates by 0.50%. With Japanese interest rates currently at next to nothing (<0.10%), the Bank of Japan clearly can’t follow suit, and has therefore opted to loosen monetary policy through flooding the money markets and buying government bonds.

The two countries’ approaches are alternative ways of achieving the same basic goals - to give consumers ‘a break’ in amid social upheaval and to provide support to fragile economic growth.

The so-called policy of quantitative easing that Japan has announced this morning invariably has the effect of weakening the economy’s national currency. The US Federal Reserve’s ‘QE II’ program has been responsible for the dollar’s woeful underperformance over the past year or so. Money-printing increases supply, thus weakening the currency as demand eases.

Accordingly, the yen declined against 13 of its 16 major counterparts as markets reacted to the news. However, just as the New Zealand Dollar did in the immediate aftermath of its rate cut last week, the yen has rebounded relatively strongly. There is a sense that New Zealand’s economy may eventually benefit from Christchurch’s disaster, with its construction sector in particular expected to enjoy strong growth. The same was thought of the Japanese construction sector but the apparent devastation suffered in the country’s north-eastern region seems set to provide a genuine setback to the Japanese economy in 2011. The country has suffered major damage to its infrastructure- most notably its roads and highways, factories and nuclear plants.

Fundamentally, we can be pretty confident of one thing- the yen will not strengthen this year. The Japanese government has this morning said as much. It threatened intervention to curb any sudden yen appreciation, asserting that it “will take decisive steps if necessary” (indeed the BOJ acted on their threat in September last year, though the impact was fleeting). So anyone hoping for a yen appreciation to mirror the aftermath of Japan’s last major earthquake in 1995 will be disappointed.

Behind the government statement is the concern that Japan is an export-dependent country which relies on weaker exchange rates particularly in times of low-growth. When a government makes this sort of statement, market appetite for the related currency is understandably dampened.

Will the yen decline? Well, the scale of the disaster is continually being revised up, and in light of this morning’s government statement, the yen could be set to weaken despite a thus far robust post-quake performance. In addition, we see risk appetite increasing over the course of 2011 and anticipate that funds held in yen will be redirected to higher-yielding, riskier currencies.

Richard Driver
Analyst – Caxton FX


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