Japan in yen policy crisis
All the hard work of Abenomics has been undermined by weeks of frantic trading that has seen the yen appreciate dramatically on safe-haven flows, with QE and even an announcement on negative rates having little impact. The market is now waiting to see if the Bank of Japan has any more tricks up its sleeve.
Two weeks of chaos in the dollar/yen market has increased the tail risk of Japanese intervention in FX markets – either directly or through multilateral intervention if agreed at the meeting of G20 Finance Ministers in Shanghai next week.
Etsuro Honda, an adviser to prime minister Shinzo Abe, has indicated that the Bank of Japan might further expand its stimulus programme in its March meeting, while also suggesting a postponement of the sales-tax increases for two years and a supplementary budget.
And although this week there has been some improvement in conditions, with risk appetite increasing and upward pressure on the yen easing somewhat, market volatility – global growth, the US rate outlook, Chinese policy and commodity prices – are all still in play. With the G20 Shanghai meeting coming up, Japanese officials have indicated that multilateral intervention would be most effective at bringing sustained order back to the market.
However, this prospect seems especially remote. For one thing, such action would contradict the general principle that currencies should reflect their fundamental value and should not be manipulated. What’s more, Japan’s FX troubles are far from unique.
Andrew Kenningham, senior global economist at Capital Economics, says: “It is not even clear in which direction a 'Shanghai Accord' would try to steer exchange rates.”
While yen – and euro – weakness is creating headaches for central banks trying to reduce deflationary pressures in their economies, the dollar has appreciated by 25% in trade-weighted terms since mid-2014, making it strong by historical standards.
And the dollar issue is arguably a greater global concern, since it is fuelling commodity-price weakness and exacerbating global deflation concerns. Europeans could also argue that multilateral action on the euro is also needed, so the possibility of priority being given to the yen looks remote.
Kenningham says: “The concerns of the US, eurozone and Japan are fundamentally incompatible, which means an agreement between them on currency coordination looks like a non-starter.”
Dominic Bunning, senior FX strategist at HSBC, agrees that while multilateral interventions tend to be longer lasting than unilateral ones, agreement at the G20 to weaken one or a few currencies versus the rest is unlikely. “At the moment most major economies are trying to utilize their currencies – implicitly or explicitly – to help generate growth and inflation. They can't all devalue against each other,” he says.
The market is divided on the prospect of direct intervention from the Japanese authorities and how successful any action would be.
The first thing to note is that clues point to much of the pressure on the yen being the result of speculation, with dollar/yen positioning outright negative. This should mean “intervention would be successful in putting at least a temporary floor under USD/JPY,” says Adam Cole, head of G10 FX strategy at RBC, because it is easier to fight speculators in the near term than fundamentals. It also means a small amount of intervention could provoke a large spot move as positions are closed, he says.
Nomura estimates speculative yen net long positions in the International Monetary Market hit $8.2 billion by the middle of last week, close to its historical high of $10 billion, with the effect accentuated by relatively low liquidity during the Japanese holiday and Lunar New Year.
Authorities might also be tempted to intervene because the benefits would be felt broadly, adds Cole. “Given the current strength of cross-asset correlations, whatever the direction of causality, returning some stability to USD/JPY would very likely help restore some stability to risky assets more widely,” he says.
HSBC Global Research suggests policymakers will be eager to see the Nikkei stock market index rise back above 16,000, implying action might be imminent. This is an historically important technical level that has triggered policy action in the past, including when the Bank of Japan stepped up quantitative easing in October 2014.
History provides more evidence that now could be the time for intervention. “Japan’s authorities tend to intervene when USD/JPY depreciates by more than 3% within a week, and/or more than 5% in a month,” says Nomura in a research note. “The recent pace of JPY appreciation has been more rapid than this.”
However, Nomura acknowledges that the rhetoric of Japanese authorities implies that imminent action is not being considered.
Takahiro Sekido, Japan strategist at MUFG, believes authorities will stay their hand while dollar/yen remains above 110. He says Japanese companies have a breakeven level of 90 for dollar/yen, with the purchasing power parity on the producer’s price index at 106 late last week.
Cole says: “According to the OECD purchasing power parity, an alternative measure of valuation, JPY is still 13% undervalued (bilaterally against USD). With G20 central bank governors and finance ministers soon to meet, this may not be an opportune time to intervene to weaken an already weak JPY.”
Finance ministers and central bankers might also be coming to accept the limits of their influence in the FX markets. HSBC Global Research says in a note: “It is clear that the potency of [central bank] efforts is waning. Draghi’s attempts to talk the EUR lower at the January ECB meeting had only a fleeting impact on the currency. And Japan’s surprise move to a negative interest rate policy at the end of January similarly had only a temporary weakening impact on the JPY.”
However, it might be a bit early to write off Japan's negative rates policy as a failure. Although the reaction to the announcement was underwhelming, Nomura argues that the Bank of Japan will want to monitor how the market reacts to its actual implementation, which only started on 16 February.
The omens don't look promising. “Negative interest rates have not generated lasting FX weakness in Japan or elsewhere,” says HSBC Global Research, with the eurozone, Switzerland and Sweden among the examples of failures.
Japan's negative rates policy might have been undermined by its lack of ambition: only ¥10 trillion to ¥30 trillion of reserves are actually subject to the negative rate, compared with a QE programme running at ¥80 trillion a year.
Japan might therefore be considering direct intervention in the currency markets via yen sales. Still, this is likely to prove controversial, and although yen strength is a concern, it has not reached levels seen in 2010/11, when it last intervened directly in the market. The Bank of Japan might therefore find it difficult to justify, says Nomura.
Further easing looks a more likely response. “It is clear that the BOJ now sees JPY weakness as more structurally positive for Japanese inflation, and the Bank does not want USD/JPY to stay below 115, which would worsen inflation and the economic outlook further,” says Nomura. Another 20 basis point rate cut, alongside ETF purchases to offset any negative impact on banking stocks, is a likely option for the Bank of Japan, it adds.