Morning Brief – The battle of Japan

The battle of Japan

Trading flows have continued to pummel the Japanese Yen. Even as the USDJPY spot price crossed through 130, there was only a momentary pause before selling pressure continued. The record weakness in JPY had made headlines and forced analysts to question just how low the currency could fall. Despite a seemingly resolute standpoint from the Bank of Japan to continue to support growth and favourable financing conditions within Japan, pervasive global inflationary pressures are finding their way into the Japanese economy and undermining the credibility of monetary support. This could, if some investors are correct (I suspect they may not be), force a reversal in the Yen’s fortunes and restore it from its current depths.

Inflation remains moderate in Japan for now, but due to the near deflationary environment that Japan has experienced for several decades what most of the world would consider to be a moderate inflation level for Japan is cast in a far harsher light. So too are forecasted inflation figures for the year ahead concerning both monetary authorities and the populate alike.  Presently, the Bank of Japan maintains favourable monetary conditions that are thought to play a significant role in maintaining and developing inflationary pressures in the economy. In fact, the Bank of Japan maintains one of the most accommodative policy playbooks in the world, characterised by ultra-low interest rates, heavyweight spending programmes, a severely swollen balance sheet and even some specialist instruments.

It is one of these specialised and unique instruments that is coming under fire in markets and could hold the fundamentals to spark a reversal in the Yen’s fortune if confirmed. Yield curve control is a subject we have covered before and part of the policy toolkit of the BoJ. A less conventional tool than QE and overnight interest rate setting, the Bank explicitly dictates its tolerance for yields implied by openly traded national debt products. The Bank threatens that should the market breach pre-determined levels it will intervene thereby guaranteeing the yield curve control level. Due to inflationary pressures, many investors are now betting the BoJ will have to scrap this policy and selling debt within the most constrained parts of the yield curve in a speculative move.

There is one other factor to consider. Our own GB Pound has experienced significant selling pressure to a level at which questions have been raised about the central bank’s sensitivity towards GBP. Given that we import a huge quantity of consumables and other goods from abroad versus those we export, a weaker national currency will feed through to prices and therefore the inflation rate, exacerbating current price pressures. Our Pound has lost nearly 10% year to date versus the Dollar. This is still very far shy of the 18% decline that JPY has experienced versus the Dollar. Japan too has a significant reliance upon imports inviting that inflationary pressure onto its shores. However, before you bet on the Bank of Japan changing its tune, be reminded that this trade has burnt the fingers of many seasoned investors over the past decade. So perhaps there’s a reason why this trade has been nicknamed the ‘widow maker’ in FX markets.

Discussion and Analysis by Charles Porter

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