Japanese Yen Counting Down the Days to Massive Stimulus
Fundamental Forecast for Japanese Yen: Bearish
- Lower and Upper House confirm Kuroda, Iwata and Nakaso to Bank of Japan
- USDJPY rally covers six months and 25 percent
- Japanese Yen congestion prone to both reversal or aggressive continuation
Having dropped nearly 2,000 pips and 25 percent, the Japanese yen has finally seen one of its key fundamental milestones met: a change in leadership at the Bank of Japan (BoJ) that is focused on significantly leveraging stimulus. While the approval of the new Governor and Deputy Governors isn’t a serious capital flow diversion event in and of itself, it provides some measure of satisfaction to those that have speculated what the end game is – a more immediate adoption of a monetary easing program that will rival even the Federal Reserve. And, considering how much influence the Fed’s own efforts have had in depressing the greenback through the early years of the global rescue effort – and continues to have on equity markets today – Japan’s effort could pack a powerful punch.
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To understand the potential moving forward, we need to revisit the progression of stimulus expectations that have throttled the yen and spurred the Nikkei 225. The bullish move in the yen crosses (bearish for the Japanese currency itself as it is always used as the ‘quote’ currency in a pair) began in the lead up to the general elections in Japan as LDP Party leader Shinzo Abe campaigned heavily on the agenda of ending decades of deflation. To accomplish this objective, it was generally believed that a substantial depreciation of the national currency would result (some say required to instigate). Abe was not shy about his views, and a committed policy that drives the currency lower is not going to be ignored by investors.
After the elections, progress was made as the government urged the Bank of Japan to adopt its deflation-fighting agenda and matching gusto. With the introduction of a 2 percent inflation target and later the announcement of an open-ended, 13-trillion-yen-per-month stimulus program, the full press was apparent. This was the pinnacle of stimulus speculation and investors were fleeing yen assets and shorting the currency in advance of the actual implementation. However, the market is rather good at pricing in expectations quickly and efficiently. With the path laid out, it seemed the market was fully prepared for the future with the yen fully 25 percent cheaper.
Policy officials no doubt noted the stalled USDJPY climb; and with the G20’s warning preventing outright currency guidance, they are now moving to the next stage of escalating the speculativedrive. With Haruhiko Kuroda now placed in the top position of the Bank of Japan, we have another opportunity to revive a mature move. The transition to the new leadership happens specifically on Tuesday the 19th. There will be a not-inconsiderable segment of the market that will expect the new BoJ Governor to immediately introduce an upgrade to the stimulus effort. That can be done in a number of ways. Considering the program is already expected to trump the Fed’s by a wide margin (it would equate to approximately $135 billion per month), the size is already considerable. The most effective move would be to fast track its implementation – it is currently set to begin in January of next year (a Shirakawa protest no doubt). Less effective in driving immediate gratification to bulls would be to target new assets, longer duration or drop existing restraints.
It is critical to remember that to this point, the Japanese yen’s plunge is setting up to be a ‘buy the rumor, sell the news’ situation. We have not seen the actual financial / market changes that support the move the currency has made. And, it is a big move to live up to. If there isn’t a clear effort to put policy into motion, it could fulfill the ‘sell the news’ side of the adage. If there isn’t an ‘emergency’ meeting called shortly after the transfer of power, we could start slipping down the slope. However, with the first policy decision not until April 4 and a possible government quibble over ‘revoting’ on the BoJ leadership at the time of Shirakawa’s original resignation time (April 8), speculation could still hold out.
In the meantime, we have to consider what happens to the yen crosses should risk aversion kick in. Building up the crosses is a drive towards the carry trade, but yields are extremely thin and the pair’s exceptionally stretched. It would be hard enough for Kuroda to offset a market wave based on risk trends with active stimulus, but if there isn’t an active buffer; it could prove particularly disastrous. - JK