In my April column titled “How high for the USD/JPY?” I argued that “…108.00 may be a realistic target. The key for U.S. dollar bulls remains the extent of the next corrective pullback before renewing the gains.” Since then, the pair has rallied to break above the 100.00 yen level for the first time since April 2009. So what’s next for this aggressive pair?
Prime Minsiter Shinzo Abe’s appointment to the helm of the Bank of Japan — Haruhito Kuroda — did not disappoint. The central bank not only has changed the definition of price stability, but also redefined monetary policy easing. It is aiming to double its monetary base from ¥135 trillion to ¥270 trillion within two years and is raising the average maturity of Japanese government bonds to seven years from three years—all via a monthly expansion of its balance sheet to the tune of 1.1% of GDP, compared to 0.5% of GDP by the Fed’s $85 billion. Those intentions were announced publicly and proved sufficient in dragging the yen against all currencies. Yet more losses are in store for the Japanese currency.
Markets have witnessed a rare combination of rampant monetary easing, passive currency depreciations, disinflationary economic data and soaring equities. All of this has produced the perfect storm against both gold and the Japanese yen.
Monetary easing has emerged courtesy of the European Central Bank’s willingness to slash deposit rates below zero, the Reserve Bank of Australia’s 25-bp rate cut in its cash rate to 50-year lows, the Bank of Korea’s 25-bp cut in its base rate to three-year lows, and the Federal Reserve’s willingness to increase asset purchases. Not to mention the Bank of Japan’s monetary shock-and-awe campaign.
Currency devaluations are going beyond the usual practice of aggressive monetary easing and onto actual intervention (Reserve Bank of New Zealand’s actual selling of its own currency). Whether currency depreciation is direct or indirect by central banks, the final product remains the same. So far, the Bank of Canada (BoC) may have been the exception in avoiding asset purchases, but last week’s appointment of Stephen Polaz, head of Canada’s export agency, to the helm of the Bank of Canada means that Canadian exporters finally will find an ally at the central bank. Poloz is likely to be more attentive to the needs of exporters via capping the Canadian dollar, which was not the case with former BoC head Marc Carney.
The threat of a double dip in German growth, 33-month lows in Eurozone inflation, disappointing U.S. services and manufacturing surveys from the Institute of Supply Management, and mixed data from China have cemented the notion that inflation is nowhere to be found on the list of central banks’ priorities. Eroding signs of inflation especially have been instrumental in triggering the recent damage in gold. Regardless of the intensity of current and planned QE programs from central banks, as long as asset purchases are not transmitted out of central banks and organic growth is fading, the risk becomes that of disinflation and not inflation.
It is easier for asset purchases to boost asset prices than the real economy. The widening disconnect between market metrics and macroeconomic data may be justified through the wealth effect argument. But as we have seen in winter-spring 2007, equities lagged behind the economy, rather the inverse. And unlike in 2007, today’s market dynamics lack the anomalies of debt-fuelled real-estate markets and sky-high commodities prices. And even if 92% of shares in the S&P 500 trade above their 200-day moving average, this remains well below the 96%-97% highs seen in 2009 and 2011.
It has been claimed by a few macro hedge fund managers that the latest yen sell-off was being used by funds’ to absorb losses in April’s gold damage. But there is another angle. Yield-searching Japanese investors gradually are shifting from “sell yen/buy gold” to “sell yen/buy global equities/buy U.S. treasuries.” As Japanese investors continue to exit their gold longs, the proceeds are likely to remain overseas, supporting equities and sovereign bonds.
As USD/JPY enters the next phase of its rally (alongside EUR/JPY and GBP/JPY), the Japanese upper house elections due in July likely will be the catalyst for Abe to exercise a rare majority in both houses of the Diet and further grease the wheels of his reflationary policy. The next major destination for the pair remains 108 as long as the November trendline support remains intact, which means no weekly close below 97.70.
Ashraf Laidi is chief global strategist at City Index-FX Solutions and author of “Currency Trading & Intermarket Analysis.” His Intermarket Insight appears daily on AshrafLaidi.com.