Today’s rise in USDJPY was a minor correction following a major sell-off and there was no sign of any activity by the Bank of Japan. But intervention remains a real possibility if and when the yen’s rally resumes. There would appear to be a window of opportunity next week, after the G20 Finance ministers and central bank governors’ meeting in Washington this Thursday/Friday and before the Bank of Japan’s monetary policy review on April 27-28.
Ministry of Finance calls the shots on exchange rate policy
It’s a common misconception that it’s the Bank of Japan’s responsibility to determine the country’s exchange rate policy. It isn’t: the Ministry of Finance makes the calls and the BoJ implements the strategy. Given his obsession with inflation, the bank’s governor, Haruhiko Kuroda, is probably hoping his hotline to the MoF rings any minute, giving him the all-clear to drive USDJPY higher. But Finance Minister Taro Aso has other considerations to take into account, not the least being the G20 meeting this week. Currency intervention, even to combat “speculators”, is a touchy subject among that group.
Most likely Kuroda will have to grin and bear it, concentrating his efforts on preparing for the BoJ’s policy board meeting on Apr 27-28, where he, like the other board members, will be presenting updated economic forecasts. Markets await with interest the inflation projections. The current forecast, issued on Jan 29, is that the year-on-year rate of increase in the Consumer Price Index will reach 0.8% this financial year (beginning April 1) and continue on an upward path to 1.8% in 2017.
However, since then the party line from Kuroda and his colleagues is that inflation “is likely to be about zero percent for the time being due to the effects of the decline in energy prices, and, as the underlying trend in inflation steadily rises, will accelerate toward 2%”.
Good luck with that Mr Kuroda: today’s global forecast updates from the International Monetary Fund project Japan’s inflation to be negative 0.2% in calendar 2016, rising to 1.2% next year and still being at that level in 2021.
Japan’s bond market traders seem to be placing their bets on the IMF’s outlook, not the the BoJ’s. Government bond yields out to 12 years are negative and the 30-year yesterday fell to a new record low of 0.39%, further widening the nominal yield spread between US Treasuries and Japanese government bonds (see chart below).
So if the yield gap in favour of the USD is rising, why is USDJPY falling? One explanation is that it isn’t the nominal yield gap that is in the driver’s seat but the real yield gap. The argument goes that because Japan’s interest rates are moving lower right across the curve while the core inflation rate holds around 1%, the real rate (i.e after inflation) is rising. Meanwhile, real rates in the US are falling modestly, as evidenced by the five-year TIPS yield dropping back under zero as the markets push out the timing of the next US Federal Reserve rate hike.
So on this basis you can make an argument that the real yield spread is moving in favour of Japan; hence the rally in the yen (and decline in USDJPY).
Trade Weighted Index rise not matching USDJPY
Confounding virtually everyone, the yen has rallied strongly since the Bank of Japan added a “third dimension” (negative rates) to its monetary policy arsenal on Jan 29. USDJPY has dropped from 121 to 108, representing a 11% rally against the dollar. Yet Japan’s Effective Exchange Rate (or Trade Weighted Index) has only risen by half that amount (see chart below: Click to enlarge). That’s because the US dollar has only a mid-rank weighting in the index.
So FX traders clamouring for the Ministry of Finance to “do something” about USDJPY would be wise to factor in that officials are more interested in the overall level of Japan’s exchange rate:
Is a 6% rally in the effective exchange rate enough to be of concern?
Japan effective exchange rate
Source: Bank of Japan.
Regardless, the Bank of Japan is probably pushing the authorities to give them authority to intervene in the FX markets because the decline in USDJPY is partially offsetting the oil price rally, thus diluting the flow through into desperately needed domestic inflation. In US dollar terms, oil is up about 55% off its lows but in JPY terms only 40%.
The rally in JPY has come at an awkward time for the bosses of Japan’s Ministry of Finance and the Bank of Japan. It wouldn’t be a good look for them to be battling currency speculators as they meet with G20 counterparts this week.
On the other hand, the bank board members are preparing new economic forecasts for their April 27-28 meeting, and factoring in USDJPY at current levels will not allow them to hold the line on the current forecast that inflation will rise to 2% in 2017.
In between these two events perhaps there is a window of opportunity to return the exchange rate to a level that “better reflects the fundamentals”.
Technical analysis of USDJPY appears below.